London
CNN business
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Pension funds are designed to be dull. Their sole goal of making enough money to pay retirees favors cold minds over cocky risk-takers.
But as the UK market was turbulent last week, hundreds of UK pension fund managers have found themselves at the center of a crisis that has forced the Bank of England to step in to restore stability and avert a wider financial collapse.
It was just one big shock. After Finance Minister Kwasi Kwarten announced plans to borrow more to pay for his tax cuts on Friday 23 September, investors sold off sterling and British government bonds, pushing yields on some debt to record highs. soared.
The scale of the turmoil has put a lot of pressure on many pension funds, upending investment strategies that include using derivatives to hedge bets.
As the price of government bonds plummeted, funds were asked to raise billions of pounds as collateral. In a race for cash, investment managers were forced to sell whatever they could. In some cases, they even sold more government bonds. This has pushed yields higher and brought another wave of collateral calls.
Ben Gold, Head of Investments at UK pension consultancy XPS Pensions Group, said: “Everyone wanted to sell, but there were no buyers.”
The Bank of England has entered crisis mode. After working until the evening of Tuesday 27 September, it entered the market the next day with a promise to buy up to £65 billion ($73 billion) of bonds if needed. This stopped the bleeding and averted a “self-reinforcing spiral” and “broader financial instability”, the worst concerns the central bank later told lawmakers.
In a letter to the chairman of the UK Parliament’s Treasury Committee this week, the Bank of England said many funds would have defaulted if it had not intervened, adding to the strain on the financial system. He said the intervention was essential to “restore the functioning of the core markets.”
Pension funds are now scrambling to raise funds to replenish their coffers. Still, there are doubts as to whether they will be able to find a foothold before the Bank of England’s emergency bond purchases, which are due to end on 14 October, end.
For the first time in decades, interest rates are rising rapidly around the world. In such a climate, markets are prone to accidents.
Barry Kenneth, chief investment officer at the Pension Protection Fund, which manages pensions for employees of bankrupt UK companies, said: “In the past two weeks, we have seen the potential for significant market volatility. “It’s easy to invest when everything is going great. It’s much harder to invest when you’re trying to catch a falling knife or have to readjust to a new environment.” increase.”
The first signs of trouble appeared with fund managers focusing on so-called “liability-driven investments” (LDIs) in pensions. Gold said he began receiving messages from concerned clients over the weekend of Sept. 24-25.
LDI is built on a simple premise. Pensions should be sufficient to pay retirees for the foreseeable future. To plan their payments in 30 or 50 years, they buy long-term bonds and derivatives to hedge these bets. In the process, they must present collateral. When bond yields rise sharply, they are asked to post more collateral in what is known as a “margin call.” This obscure corner of the market has grown rapidly in recent years, with valuations reaching his £1 trillion ($1.1 trillion), according to the Bank of England.
If bond yields rise slowly over time, it doesn’t matter for pensions with LDI strategies, it actually helps their finances. But when bond yields rise sharply, they are in for trouble. The Bank of England said the move in bond yields before the intervention was “unprecedented”. His four-day move in the UK’s 30-year bond more than doubled what was seen during the pandemic’s most stressful period.
“The sharpness and malice of movement is what really got people going,” said Kenneth.
Margin calls came in — and kept coming. The Pension Protection Fund said it faced her £1.6 billion demand for cash. I was able to repay without throwing away my assets, but I was caught off guard and forced to sell off government and corporate bonds. And stocks for fundraising. Gold estimates that at least half of the 400 pension programs advised by XPS are facing collateral demands, and across the industry, funds are now closing the £100bn to he £150bn hole. I’m here.
“With such a big move in the financial system, it’s only natural that something breaks,” said UBS strategist Rohan Khanna.
When a market malfunction sets off a chain reaction, it’s not just scary for investors. The Bank of England letter said the crash in bond markets “may have led to an excessive and sudden tightening of funding conditions for the real economy” amid soaring borrowing costs. For many businesses and mortgage holders, they already have.
So far, the Bank of England has only bought £3.8bn of bonds. Still, the initiative sends a strong signal. Yields on long-term bonds have fallen sharply, giving pension funds time to recover, but have recently begun to rise again.
“What the Bank of England has done is buy time for some of my colleagues,” said Kenneth.
Still, Kenneth is concerned that if the program ends next week as planned, the task will not be completed given the complexity of many pension funds. warned in a recent memo to clients that there was a “cliff edge” risk, especially as the Bank of England moved forward with plans to start selling previously purchased bonds. Pandemic at the end of the month.
“While it may be hoped that the precedent for BoE intervention will continue to provide a backstop after this date, this may not be enough to prevent another intense sell-off in long-term gold coins.” she wrote.
As central banks raise interest rates at the fastest pace in decades, investors are nervous about the impact on their portfolios and the economy. They hold more cash, which can make it harder to execute trades and exacerbate uncomfortable price fluctuations.
As such, surprise events are more likely to wreak massive havoc, and the specter of the next Shocker looms large. Is it a rough batch of economic data? Trouble with global banks? Another British political failure?
Gold said the pension industry as a whole was ready, but admitted it was “naive” to think that instability could never happen again.
“We will need yields to rise sooner than this time,” he said, noting that a larger buffer fund is now amassed. “It takes something of absolutely historic proportions for that to be insufficient, but you never know.”
