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Analysis: Underwater: how the Bank of England threw a lifeline to the markets

  • The Bank of England bought bonds after demands from pension funds
  • Some UK pension funds have faced problematic margin calls
  • BoE support seen as window to post collateral
  • UK government’s unfunded tax plan spooked markets

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

Wild swings in financial markets in response to a government ‘mini budget’ on September 23 meant whole swathes of Britain’s pension system were in jeopardy, sparking widespread concerns about the country’s financial stability.

UK Finance Minister Kwasi Kwarteng’s statement included dramatic plans to cut taxes and pay them with borrowing that sent government bond yields soaring.

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

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

Obscure financial instruments designed to match long-term pension liabilities with assets, which had never been tested by bond yields moving this far or this quickly, were in danger of blowing up.

Among those making urgent calls to the BoE were funds managing so-called passive investments (LDI), a seemingly simple hedging strategy at the heart of the explosion.

The LDI market has exploded over the past decade and assets total nearly £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 gilts after struggling to meet emergency demands from LDI funds for collateral on “underwater” derivative positions, where the value is lower than that recorded on the books of a fund.

LDI funds were calling for urgent cash to shore up loss-making positions. The funds themselves faced margin calls from their relationship banks and other key financial players.

“We laid the cards on the table. You don’t expect them (the BoE) to give you back much because they won’t show you their hand, do you?” said James Brundrett of retirement consultant and fiduciary manager Mercer, who held a meeting with the BoE on Sept. 26. “Thank goodness they listened because this morning (September 28) the gilt market was not working,” he added.

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

And echoing former European Central Bank boss Mario Draghi, at the height of the eurozone debt crisis, the central bank pledged to do whatever it took to bring stability financial.

While that may have eased the immediate pressure on pension funds, it’s far from clear how much time the BoE has gained as shock waves ripple through global markets from newly appointed Prime Minister Liz’s plan. Truss, which, in addition to spooking investors, drew a rare rebuke from the IMF.

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

Gilts, Sterling and FTSE250

At the end of a turbulent week, many pension funds were still liquidating positions to meet collateral demands and some were asking the companies they manage money for to bail them out with cash, sources said. to Reuters on Friday. The Bank of England is pulling out of 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 continued we would be in serious trouble,” a fund manager at a large UK company pension scheme told Reuters.

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

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

BlackRock said in an emailed statement on Friday that it was reducing the funds’ leverage and had not halted their trading.


The possibility of the stress spreading beyond the pension funds and throughout the UK financial sector was real. If the LDI funds defaulted on their positions, the banks that had arranged the derivatives would also be sucked in.

Massive stress on the financial system of a major economy has sent global waves, even safe-haven US Treasuries and top-rated German bonds have been hit. Atlanta Fed President Raphael Bostic warned on Monday that events in Britain could lead to greater economic tension in Europe and the United States.


As the BoE’s intervention sent yields tumbling, bringing the yield on 30-year bonds back to September 23 levels and easing fears of an immediate crisis, fund managers, pension experts and analysts say Britain is far from out of the woods.

Nobody knows how much plans will have to sell and what will happen once the BoE stops buying bonds on October 14.

The British central bank now finds itself in the unenviable position of having postponed its bond sale plan, which has led to monetary easing and at the same time interest rate tightening.

In November, he is expected to raise rates again and he said he would stick to a plan to sell his bonds.

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


Investor confidence has been shaken, not just in Britain.

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

“What you don’t do is go take taxpayers’ money and buy 4% bonds,” Druckenmiller said. “It creates long-term problems down the road.”

Standard & Poor’s on Friday downgraded its AA credit rating outlook for Britain’s sovereign debt from “negative” to “stable”, saying Truss’ tax cut plans would lead to a continued rise in debt.

Meanwhile, demand for U.S. dollars in currency derivatives markets rose to its highest level since the peak 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 concerned.

“This is the first time we’ve seen a large, developed market in a very 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; Editing by Elisa Martinuzzi and Alexander Smith

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