Analysis: Behind the scenes: How the Bank of England threw a lifeline on the market

LONDON/NEW YORK (Reuters) – Calls to the Bank of England began on Monday saying some of Britain’s pension funds are struggling to meet margin calls. By Wednesday, they were becoming more urgent and coordinated.

The volatility in financial markets in response to the government’s ‘mini-budget’ on 23 September means that parts of the UK pension system are at risk, raising widespread concerns about the country’s financial stability. caused it.

UK Finance Minister Kwasi Kwarten’s statement included a dramatic plan to finance the economy with tax cuts and borrowing that would lead to higher yields on government bonds.

The next day, UK borrowing costs surged to their highest level in decades and the pound plummeted to record lows.

But while these reactions were obvious to everyone, there was a hidden impact behind the screens of financial markets.

At risk of failure were vague financial instruments designed to match long-term pension obligations and assets.

Calling the BoE urgently were funds managing so-called liability-driven investments (LDIs).

The LDI market has boomed over the past decade, with total assets reaching nearly £1.6 trillion ($1.79 trillion), more than two-thirds the size of the UK economy.

Pension plans forced to sell government bonds, known as gold coins, after finding it difficult to meet urgent demands from LDI funds for collateral for ‘underwater’ derivative positions worth less than the fund’s book value it was done.

The LDI Fund was in urgent need of cash to reinforce its loss-making positions. The fund itself faced margin demands from concerned banks and other major financial players.

“We put our cards on the table. Since they (BoE) won’t show you your hand, you don’t expect them (BoE) to give you much back, do you?” Sept. James Brundrett, pension consultant and trustee manager Mercer, who met with the Bank of England on the 26th, said: “The gold coin market wasn’t working this morning (September 28th) and I hope they listened. Thank God for that,” he said.

Faced with a market meltdown, the BoE stepped in with a £65 billion ($72.3 billion) package to buy long-term gold plating.

Also, following in the footsteps of former European Central Bank President Mario Draghi at the height of the eurozone debt crisis, the central bank promised to do whatever it takes to bring about financial stability.

This may have eased the immediate pressure on pension funds, but how much time the BoE has bought remains to be seen as shockwaves spill over to global markets from the plans of recently appointed Prime Minister Liz Truss. Not obvious. IMF rebuke.

UK Treasury Secretary Chris Philp said on Thursday he disagreed with the IMF’s concerns about the government’s tax cut budget, saying it would lead to long-term economic growth.

By the end of the tumultuous week, many pension funds were still liquidating positions to meet collateral demands, with some asking the companies controlling the funds to bail them out in cash. , a source told Reuters on Friday. “The question is what happens if the Bank of England pulls out of this market?” Mercer’s Blandret added that there is an opportunity for pension funds to raise enough money to strengthen their collateral positions.

“By the end of the day (Monday) they were saying if this continued it would be a serious problem,” a fund manager at a large UK corporate pension scheme told Reuters.

“By Wednesday morning, they said it was a systemic problem. It was on the verge. It was like 2008, but it happened so fast that it needed strengthening,” said the fund manager. added.

BlackRock, another major LDI manager, told clients on Wednesday it would not be able to replenish the collateral needed to maintain positions, according to a BlackRock memo seen by Reuters.

BlackRock released an emailed statement on Friday, saying it was de-leveraging the fund and had not halted trading.

not out of the woods

The potential for stress to spill over not only to pension funds, but to the UK financial industry as a whole was real. If the LDI fund defaults on its position, the bank that arranged the derivatives will also be sucked.

Massive stress on the financial systems of the major economies triggered a global wave that hit safe havens such as US Treasuries and even the highest rated German Bunds. Atlanta Fed President Bostic warned that the events in the UK could add to economic stress in Europe and the US.

While the Bank of England’s intervention sent yields plummeting, pushing 30-year Treasury yields back to September 23 levels and easing fears of an impending crisis, fund managers, pension experts and analysts It states that Britain is far from getting out of the woods.

No one knows how much the scheme will need to sell and what will happen if the BoE stops buying bonds on October 14th.

The UK central bank is now in the enviable position of postponing its plan to sell government bonds, resulting in monetary easing and tightening of interest rates at the same time.

With another rate hike slated for November, he said he would stick with his plan to sell bonds.

“The concern is that the market sees this as something to test, and I don’t think banks want to set a precedent for this,” said Orla Garvey, fixed income manager at Federated Hermès. This continues to leave Longgilt vulnerable.” .

Investor confidence is shaken, not just in the UK.

Billionaire investor Stanley Druckenmiller said: “The situation in the UK is very dire as 30% of mortgages are going to floating rates.

“What you shouldn’t do is take taxpayers’ money to buy a 4% bond,” Druckenmiller said. “This will cause long-term problems going forward.”

Standard & Poor’s on Friday cut its AA credit rating outlook on UK sovereign debt to ‘negative’ from ‘stable’, saying debt will continue to rise as a result of Truss’ tax cut plans.

Meanwhile, US dollar demand in the currency derivatives market on Friday surged to its highest level since the height of the COVID-19 crisis in March 2020.

Ken Griffin, billionaire founder of Citadel Securities, one of the world’s largest market-making firms, is concerned.

“This is the first time in a very long time that a major developed market has lost investor confidence,” Griffin said at an investor conference in New York.

($1 = £0.8994)

Additional reporting by Sinead Cruise, Davide Barbuscia, and Iin Withers. By Megan Davies. Edited by Elisa Martinuzzi and Alexander Smith

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