© Reuters. FILE PHOTO: View of the Bank of England (BoE) building, BoE confirms rate hike to 1.75%, in London, Britain, August 4, 2022. REUTERS/Maja Smiejkowska
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By Carolyn Cohn, Tommy Wilkes and Carolina Mandl
LONDON/NEW YORK (Reuters) – Calls to the Bank of England say some UK pension funds are struggling to meet margin calls that began on Monday. By Wednesday, they had become more urgent and coordinated.
Violent fluctuations in financial markets in response to the government’s “small budget” on September 23 mean Britain’s pension system is at risk, raising widespread concerns about the financial stability of the country.
British Finance Minister Kwasi Kwarteng’s statement includes dramatic plans to cut taxes and pay with borrowing, sending government bond yields soaring.
In the days that followed, British borrowing costs rose by the most in decades, while the pound plunged to a record low.
But while these reactions are obvious for all to see, behind the scenes financial markets have a potential impact.
At risk of being blown away are cryptic financial instruments that match long-term pension liabilities with assets, which have never been tested by how quickly or slowly bond yields rise.
Among those urgently calling for the BoE were funds that manage so-called liability-driven investments (LDIs), a seemingly simple hedging strategy at the heart of the explosion.
The LDI market has exploded over the past decade and total assets are close to £1.6 trillion ($1.79 trillion) – more than two-thirds the size of the UK economy.
Pension schemes have been forced to sell government bonds known as backend bonds after they found it difficult to meet urgent demand from LDI funds for collateral on ‘underwater’ derivatives positions. , where the value is lower on the fund’s books.
LDI funds are calling for urgent cash to shore up losing positions. The funds themselves are facing margin calls from their relationship banks and other key financial firms.
“We’ve put our cards on the table. You don’t expect them (BoE) to pay you back much because they won’t show you their hand, do you?” James Brundrett of retirement consultant and trust manager Mercer, held a meeting with the BoE on September 26. “Thank God they listened because this morning (September 28), the plating market gold doesn’t work,” he added.
Faced with a market downturn, the BoE stepped in with a £65 billion ($72.3 billion) package to buy aged gilts.
And echoing the words of former European Central Bank chief Mario Draghi at the height of the eurozone debt crisis, the central bank pledged to do whatever was necessary to bring about financial stability main.
While this may have eased immediate pressure on pension funds, it remains unclear how much time the BoE bought as shock waves reverberated across global markets from its plans. The recently identified Prime Minister Liz Truss, as well as mislead investors, has drawn a rare reprimand from the IMF.
Chris Philp, secretary general of the UK Treasury, said on Thursday he disagreed with the IMF’s concerns about the government’s budget cuts, arguing it would lead to economic growth in the long run.
IMAGES: Gilts, Sterling and FTSE250 https://fingfx.thomsonreuters.com/gfx/mkt/jnvweqwzlvw/One.PNG
At the end of a volatile week, many pension funds are still liquidating positions to meet collateral requirements, and some are asking companies with which they manage money to bail them out in cash. , sources told Reuters on Friday.
“The question is what will happen when the Bank of England pulls out of this market?” Mercer’s Brundrett said, adding that there is an opportunity for pension funds to have enough money together to bolster collateral positions.
“Late today (Monday) we said if this continued we would be in serious trouble,” a fund manager at a major UK corporate pension scheme told Reuters. .
“By Wednesday morning, we said it was a systemic problem. We were on the verge. It was like 2008 but on steroids because it happened so quickly,” the fund manager added.
BlackRock (NYSE:), another major LDI manager, told clients on Wednesday that it would not allow them to add the collateral needed to hold an open position, a note from BlackRock was reported. Reuters shows.
BlackRock said in an emailed statement on Friday that it is reducing leverage in funds and that it will not stop trading among them.
NOT OUT OF WOOD
The potential for stress beyond pensions and throughout the UK financial industry is real. If LDI funds default on their positions, banks that have arranged derivatives will also be sucked in.
Massive stress on the financial system of a major economy has sent shockwaves across the globe, with even safe-haven US Treasuries and top-rated German bonds taking a hit. Atlanta Fed President Raphael Bostic on Monday warned events in Britain could lead to greater economic stress in Europe and the United States.
IMAGE: Dollar versus other currencies https://fingfx.thomsonreuters.com/gfx/mkt/zjpqkxwxopx/pound%20dollar.PNG
While the BoE intervention sent yields plummeting, pushing 30-year bond yields back to September 23 levels and easing fears of an immediate crisis, fund managers, experts pensioners and analysts say Britain is far from coming out of the woods.
No one knows how much the plans will need to sell and what will happen when the BoE stops buying bonds on October 14.
The Bank of England is currently in the inevitable situation of postponing its bond sales plan, leading to monetary easing while tightening interest rates.
In November, it is expected to raise rates further, and it has said it will stick to its bond sale plan.
Orla Garvey, a fixed income manager at Federated Hermes, said: “The concern is that the market sees this as something to be tested and I don’t believe the Bank will want to set this precedent. (NYSE:).
IMAGE: UK government bond spreads https://fingfx.thomsonreuters.com/gfx/mkt/xmpjozrzqvr/gilt%20spread.PNG
Investor confidence has been shaken, not just in the UK.
Billionaire investor Stanley Druckenmiller said: “The situation in the UK is quite dire as 30% of mortgages are heading towards variable interest rates.
“What you don’t do is go take taxpayers’ money and buy bonds at 4%,” says Druckenmiller. “This is creating long-term problems.”
Standard & Poor’s cut its AA credit rating outlook on UK government debt on Friday to “negative” from “stable”, saying Truss’ tax cut plan would keep debt rising.
Meanwhile, demand for the US dollar in currency derivatives markets surged to the highest level since the peak of the COVID-19 crisis in March 2020 on Friday, as market turmoil caused investors looking for cash.
Ken Griffin, the billionaire founder of Citadel Securities, one of the world’s largest market-makers, is concerned.
“This is the first time we’ve seen a big bull market, in a very long time, lose confidence from investors,” Griffin told an investor conference in New York on Wednesday.
(1 dollar = 0.8994 pounds)
