“This week’s unprecedented intervention from the Bank of England leading to the purchase of £5bn long-dated UK government bonds, highlighted the material risk to financial stability posed by dysfunction in the gilt markets, and the threat to UK financial stability.
“While higher yields are ultimately beneficial to pension schemes, schemes with interest rate hedging have been required to find cash to meet collateral calls at increasing short notice as large upwards moves in yields occurred in quick succession. For schemes with collateral waterfalls in place, sources of liquidity will have become increasingly depleted given the scale and speed of the upwards move in rates and yields year to date, which have only intensified in the past week. If schemes are unable to meet collateral calls, they face the prospect of being required to reduce leverage, and hedging levels, within their LDI solution. The potential for multiple pension schemes unwinding hedges concurrently within a short time frame, would result in selling more gilts into the market. This would exacerbate the existing technical headwinds, placing additional upwards pressure on yields, triggering further collateral calls, and reducing market liquidity.
“We anticipate there will be continued pressure on bond, credit, and other liquid markets as schemes continue to liquidate assets to meet collateral calls and de-leverage their LDI solutions. The most common forms of collateral may continue to see acute technically-driven selling pressure in the coming days and weeks. The intervention from the Bank of England has improved liquidity and provided some welcome relief, but we would stress the need for trustees to use this time to continue to keep their foot to the floor with regards to ensuring collateral sufficiency whilst also balancing resulting investment risk and return needs.
“The unprecedented market movements have put a strain on many clients and schemes and we are committed to working with all of our clients to navigate the way through this and ensure they are well placed to withstand any ongoing volatility and markets stresses.“
A copy of our market commentary can be found here.
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