A large number of the £1 trillion of pension funds using liability driven investment (LDI) strategies would have gone bust rendering defined benefit schemes worthless if the Bank of England hadn’t intervened, MPs were told today.
The Bank of England said pension funds with more than £1 trillion of assets were put under extreme strain, with many close to going bust.
Without the Bank of England’s intervention to buy £65bn of long-dated Gilts, funds would have gone bust, it said.
In a letter to the Rt Hon Mel Stride MP, chair of the Treasury Committee, Sir Jon Cunliffe, deputy governor, financial stability at the Bank of England said: “Against the backdrop of an unprecedented repricing in UK assets, the Bank announced a temporary and targeted intervention on Wednesday 28 September to restore market functioning in long-dated government bonds and reduce risks from contagion to credit conditions for UK households and businesses. The announcement was for temporary purchases of long-dated UK government bonds, starting that day.
The letter says that on the morning of Tuesday 27 September there was a 20 basis points fall in 30 year gilt yields but that reversed as the day progressed and by that evening 30 year gilt yields had risen by 67 basis points compared to that morning.
The Bank says it was informed by a number of LDI fund managers that, at the prevailing yields, multiple LDI funds were likely to fall into negative net asset value. As a result, it was likely that these funds would have to begin the process of winding up the following morning. In that eventuality, a large quantity of gilts, held as collateral by banks that had lent to these LDI funds, was likely to be sold on the market, driving a potentially self-reinforcing spiral and threatening severe disruption of core funding markets and consequent widespread financial instability.
The Bank’s intervention was announced late morning on Wednesday 28 September, leading to a more than 100 basis point fall in 30 year gilt yields that day.
The letter says: “Had the Bank not intervened on Wednesday 28 September, a large number of pooled LDI funds would have been left with negative net asset value and would have faced shortfalls in the collateral posted to banking counterparties. DB pension fund investments in those pooled LDI funds would be worth zero. If the LDI funds defaulted, the large quantity of gilts held as collateral by the banks that had lent to these funds would then potentially be sold on the market. This would amplify the stresses on the financial system and further impair the gilt market, which would in turn have forced other institutions to sell assets to raise liquidity and add to self-reinforcing falls in asset prices. This would have resulted in even more severely disrupted core gilt market functioning, which in turn may have led to an excessive and sudden tightening of financing conditions for the real economy.”
