Analysis: Underwater: How the Bank of England threw markets a lifeline

Analysis: Underwater: How the Bank of England threw markets a lifeline
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  • Bank of England bought bonds after pleas from pension funds
  • Some UK pension funds faced problematic margin calls
  • BoE support is seen as a window to generate guarantees
  • UK government’s unfunded tax plan spooked markets

LONDON/NEW YORK, Oct 2 (Reuters) – Calls to the Bank of England saying some British pension funds were struggling to meet margin calls began on Monday. By Wednesday they were becoming more urgent and coordinated.

Wild gyrations in financial markets in response to a government “mini-budget” on September 1. The 23rd meant parts of Britain’s pension system were at risk, raising widespread concerns about the country’s financial stability.

British Finance Minister Kwasi Kwarteng’s statement included dramatic plans to cut taxes and pay them off with loans, sending government bond yields soaring.

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In the days that followed, Britain’s borrowing costs rose to the highest in decades, while the pound plunged to a record low.

But while these reactions were for all to see, behind the screens of the financial market there was a hidden impact.

At risk of blowing up were obscure financial instruments meant to match long-term pension liabilities with assets, never tested by bond yields moving as much or as fast.

Among those calling urgently on the BoE were funds running so-called liability-driven investments (LDIs), a seemingly simple hedging strategy at the center of the blowout.

The ILD market has boomed in the last decade and assets now stand at nearly £1.6 trillion ($1.79 trillion), more than two-thirds the size of the UK economy.

Pension plans were forced to sell government bonds known as gilts after they found it difficult to meet emergency demands from LDI funds for guarantees on ‘underwater’ derivative positions, where the value is less than in the books in a background.

LDI funds were asking for urgent cash to shore up deficit positions. The funds themselves were facing margin calls from their relationship: banks and other key financial players.

“We put our cards on the table. You don’t expect them (the BoE) to give you back much because they’re not going to show you their hand, are you?” said James Brundrett of pension consultant and trustee Mercer, who met with the BoE on September 1. 26. “Thank God you heard because this morning (September 28), the gold market was not operating,” he added.

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

And echoing former European Central Bank chief Mario Draghi, at the height of the eurozone’s debt crisis, the central bank vowed to do whatever it takes to achieve financial stability.

While this may have relieved immediate pressure on pension funds, it is far from clear how much time the BoE has bought as shock waves reverberate across global markets from newly appointed Prime Minister Liz Truss’s plan, which also to scare investors generated a rare rebuke from the IMF.

Chris Philp, the UK’s chief treasury secretary, said on Thursday that disagreed with IMF concerns on the government’s tax cut budget, saying it would lead to long-term economic growth.

truss on sunday defended his plan and gave no indication that he would back down, although he did say the proposal to cut taxes for the wealthiest was Kwarteng’s decision, in the first sign that he may be distancing himself from the chancellor.

Gilts, Sterling and FTSE250

At the end of a turbulent week, many pension funds were still liquidating positions to meet collateral requests, with some asking the companies for which they manage the money to bail them out with cashsources told Reuters on Friday. “The question is what happens when the Bank of England withdraws from this market?” Mercer’s Brundrett said, adding that there is a window of opportunity for pension funds to raise enough money to shore up collateral positions.

“At the end of the day (Monday) we were saying that if this continues we will be in serious trouble,” a fund manager for a large British corporate pension plan told Reuters.

“By Wednesday morning we were saying this is a systemic problem. We were on the brink. It was like 2008 on steroids because it happened so fast,” added the fund manager.

BlackRock, another large LDI manager, told clients on Wednesday that it would not allow them to replenish collateral needed to hold an open position, a BlackRock note seen by Reuters shows.

BlackRock said in an emailed statement Friday that it was reduce leverage on funds and that he did not stop trading with them.


The possibility of tension spreading beyond pension funds and throughout the British financial industry was real. If the LDI funds defaulted on their positions, the banks that had contracted the derivatives would also be taken over.

The enormous strain on the financial system of a major economy made waves around the world, with even US Treasuries and top-rated German bonds taking a hit. Atlanta Fed President Raphael Bostic warned on Monday that events in Britain could lead to further economic strain in Europe and the United States.


While BoE intervention sent yields plummeting, pushing 30-year bond yields through September 1. 23 and allaying fears of an immediate crisis, fund managers, pension experts and analysts say Britain is far from out of the woods.

Nobody knows how much the schemes will need to sell and what will happen once the BoE stops buying bonds on October 1. fourteen.

Britain’s central bank is now in the unenviable position of having postponed its plan to sell bonds, resulting in monetary easing and, at the same time, tightening interest rates.

In November, he is expected to raise rates further and has said he will stick to a plan to sell his bonds.

“The concern would be that the market sees this as something to be tested and I don’t think the bank wants to set this precedent. This continues to leave long gilts vulnerable,” said Orla Garvey, manager of fixed income at Federated Hermes. .


Investor confidence has taken a hit, not just in Britain.

“The situation in England is quite dire because 30% of mortgages are moving to variable rates,” said billionaire investor Stanley Druckenmiller.

“What you don’t do is go and take taxpayer money and buy 4% bonds,” Druckenmiller said. “This is creating long-term problems in the future.”

standard and poor cut perspective for its AA credit rating on British sovereign debt on Friday to “negative” from “stable,” saying Truss’s tax-cut plans would see the debt continue to rise.

Meanwhile, demand for US dollars in currency derivatives markets surged to its highest level since the height of the COVID-19 crisis in March 2020 on Friday, as market turmoil sent investors looking for cash.

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

“It represents the first time we’ve seen a large developed market, in a long time, lose investor confidence,” Griffin said at an investor conference in New York on Wednesday.

($1 = 0.8994 pounds)

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Additional reporting by Sinead Cruise, Davide Barbuscia, and Iain Withers; Written by Megan Davies; Edited by Elisa Martinuzzi and Alexander Smith

Our standards: The Thomson Reuters Trust Principles.

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