Analysis: Underwater: How the Bank of England has delivered a lifeblood to the markets

  • Bank of England bought bonds after pension fund pleas
  • Some UK pension funds have faced problematic margin calls
  • BoE support is seen as giving an opportunity to build collateral
  • The British government’s unfunded tax plan scared the markets

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

Unbridled volatility in financial markets in response to the government’s “mini-budget” on September 23 meant that sections of Britain’s pension system were at risk, sparking widespread concerns about the country’s financial stability.

British Chancellor of the Exchequer Kwasi Quarting’s statement included dramatic plans to cut taxes and drive them up by borrowing, driving up government bond yields.

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

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

Obscure financial instruments at risk of detonation were intended to match long-term pension liabilities with assets, which had not previously been tested by bond yields that moved so far or too fast.

Among those who urgently called the Bank of England were funds managing so-called liability-driven investments (LDI), a seemingly simple hedging strategy at the heart of the explosion.

The LDI market has boomed in the past decade and total assets are around 1.6 trillion pounds ($1.79 trillion) – more than two-thirds the size of the UK economy.

Pension schemes have been forced to sell government bonds known as government bonds after finding it difficult to meet contingent requests from LDIs for collateral on “underwater” derivative positions, where the value is lower than that on the fund’s books.

LDI funds were calling in short funds to support losing positions. The funds themselves were facing margin calls from their associated banks and other major financial players.

“We’ve put our cards on the table. Don’t expect them (the Bank of England) to give you back too much because they won’t show you their hands, right?” Said James Brundrett of pension advisor and credit manager Mercer, who held a meeting with the Bank of England on September 26. “Thank God they listened because this morning (September 28), the gold market was not working,” he added.

In the face of the market crash, the Bank of England stepped in with a 65 billion pound ($72.3 billion) package to buy long-term bonds.

Echoing what former European Central Bank President Mario Draghi said at the height of the eurozone debt crisis, the central bank pledged to do whatever it takes to achieve financial stability.

While this may have relieved immediate pressure on pension funds, it is not at all clear how much time the BoE has bought as shock waves reverberate in global markets from Prime Minister Liz Truss’s recently outlined plan, which in addition to raising fears investors. IMF rebuke.

British Chancellor of the Exchequer Chris Phillip said on Thursday he did not agree with the International Monetary Fund’s concerns about the government’s budget for tax cuts, saying it would lead to long-term economic growth.

JLT, GBP and FTSE250

Sources told Reuters on Friday that by the end of a turbulent week, many pension funds were still liquidating their positions to meet collateral requests and some were asking the companies they manage their money to bail them out with cash. Will the Bank of England withdraw from this market? Mercer Brundrett said, adding that there is an opportunity for pension funds to get enough money together to support escrow positions.

“At the end of the day (Monday) we were saying if this continues we are in serious trouble,” a fund manager at a large British corporate pension scheme told Reuters.

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

BlackRock, another senior manager of LDI, told clients on Wednesday that it would not allow them to renew the collateral needed to keep the position open, according to a note from BlackRock seen by Reuters.

BlackRock said in an emailed statement on Friday that it will reduce the leverage in the funds and that it has not stopped trading in them.

Not from wood

The potential for pressure to move beyond pension funds and across the British financial industry was real. If LDIs defaulted on their positions, the banks that arranged the derivatives would also be sucked up.

The massive pressure on the financial system of a major economy has sent global waves, even the safe-haven US Treasuries and the top-rated German bonds. Atlanta Federal Reserve Chairman Rafael Bostick warned on Monday that events in Britain could lead to greater economic stress in Europe and the United States.


While the Bank of England’s intervention lowered yields, pushing the 30-year bond yield 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.

No one knows how much the schemes will need to sell, and what will happen once the Bank of England stops buying bonds on October 14.

The Bank of England is now in the unenviable position of postponing its plan to sell bonds, leading to monetary easing, while at the same time tightening interest rates.

It is expected to raise interest rates further in November and has said it will stick to the plan to sell its bonds.

“The concern may be that the market sees this as something to be tested and I don’t think the bank will want to set this precedent. This continues to leave long credit bonds vulnerable,” said Orla Garvey, director of fixed income at Federated Hermes. .


Investor confidence was shaken, not only in Britain.

Billionaire investor Stanley Druckenmiller said: “The situation in England is very dangerous because 30% of mortgages are going towards variable rates.”

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

Standard & Poor’s cut the outlook for its AA credit rating on Britain’s sovereign debt on Friday to “negative” from “stable”, saying that Truss’ tax cut plans would keep debt rising.

Meanwhile, demand for the dollar in currency derivatives markets jumped to its highest level since the peak of the Covid-19 crisis in March 2020 on Friday, as market turmoil prompted investors to seek liquidity.

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

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

(dollar = 0.8994 pounds)

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Additional reporting by Sinead Cruz, Davide Barbuscia and Ian Withers. Written by Megan Davis. Editing by Elisa Martinozzi and Alexander Smith

Our criteria: Thomson Reuters Trust Principles.

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