Before the Bank of England took action, pension funds were on the verge of a calamity
The Bank of England said many pension funds nearly went bankrupt when it decided to intervene in the United Kingdom’s long-dated bond market last week.
New fiscal policy announcements by the UK government caused massive selling of gilts, or UK government bonds. The factort central bank Financial Policy Committee intervened on September 23 was why.
LDI funds are invested primarily in long-term bonds. If people panicked over plummeting bond values, then about $1.69 trillion worth of LDIs would be affected. Roughly two-thirds of LDIs’ assets are in long-term British bonds.
Approximately two-thirds of LDI funds’ valued bonds are gilts that have an unusual term length. When people saw the fall in bond values, they panicked.
Workplace pensions are common in the UK. These plans provide a lifetime income for employees based on their final salary or average salary. An LDI is typically owned by a final salary pension plan.
The LDIs needed to fully liquidate long-term gilt positions as bond values dropped early last week. If gilt prices stay low, the LDIs could have handed off their positions in an orderly fashion.
Bank of England Deputy Governor Jon Cunliffe stated that LDIs issued warnings on Sept. 27 about the evening of the 27th, since the price of 30-year gilts declined from morning to evening by 67 basis points. Yields move inversely to prices.
Several equity fund managers informed the bank that current interest rates made it likely that multiple LDI funds would have negative net asset values. Because of this, it was likely that morning that fund winding down would start.
Any gilts held as collateral by banks lending money to LDI funds are likely to be sold on the market. This would cause a potentially self-reinforcing spiral that could cause significant financial instability.
The Bank of England discussed their current crisis with the Treasury Department on Tuesday night. Both departments agreed to an indemnity agreement the next morning for a rescue operation. Firms within the Treasury Department worked through the night Tuesday to come up with a solution.
The bank’s announcement providing a 30-day gilt yield relief offered markets a needed reprieve.##30-year gilt yields dropped more than 100 points after the announcement on Wednesday September 28.
According to Cunliffe, massive gilt yield boosts occurred over a 30-year period. TheJumpnote notes that Cunliffe found this increase in scale to be “unprecedented.” More than 35 basis points were added to daily gilt yields every day.
Over 4 days, the massive increase in 30-year gilt yields far exceeded the largest move since 2000. That year, investors flocked to cash investments due to the “dash for cash”. commentsdaveto on what the data showed about gilts
The gilt market suffered significant harm due to the large move. Especially at the long end of the curve, market functioning was greatly impaired.