Analysis: Under water: How the Bank of England saved the markets

  • The Bank of England bought the bonds at the request of the pension fund
  • Some UK pension funds have experienced problematic margin calls
  • BoE support is seen as providing a window to build bailouts
  • The British government’s unfunded tax plan spooked markets

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

Wild swings in financial markets in response to the government’s “mini-budget” on September 23 meant parts of Britain’s pension system were at risk, raising widespread concerns about the country’s financial stability.

A statement by British Chancellor of the Exchequer Kwasi Kwarteng included dramatic plans to cut taxes and pay with borrowing, which boosted government bond yields.

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

But while these reactions were obvious to all, there was a hidden influence behind the financial market screens.

Obscure financial instruments designed to match long-term pension liabilities with assets never tested before or with bond yields moving so fast were at risk of implosion.

Among those urgently calling on the BoE were funds managing liability-based investments (LDIs), the seemingly simple hedging strategy at the heart of the blast.

The LDI market has boomed over the past decade, with assets totaling around £1.6 trillion ($1.79 trillion), more than two-thirds of the British economy.

Pension schemes were forced to sell government bonds, known as gilts, after they struggled to meet urgent demands from LDI funds for collateral on “underwater” derivatives positions worth less than the fund’s books.

LDI funds needed immediate cash to shore up loss-making positions. The funds themselves were facing margin calls from relationship banks and other major financial players.

“We put our cards on the table. You don’t expect them (the BoE) to give you much back because they’re not going to show you their hand, do you?” James Brundrett of pensions adviser and trust manager Mercer, who held a meeting with the BoE on September 26, said. “Thank God they listened because the gilt market was closed this morning (September 28),” he said.

Faced with a market collapse, the BoE stepped in with a 65 billion pound ($72.3 billion) package to buy long-dated bullion.

Echoing former European Central Bank chief Mario Dragini at the height of the eurozone debt crisis, the central bank vowed to do everything in its power to ensure financial stability.

While this will ease immediate pressure on pension funds, it is unclear how much time the BoE will have as global markets reverberate from recently appointed Prime Minister Liz Truss’ plan. Rebuke the IMF.

UK Treasury Secretary Chris Philp said on Thursday that the IMF disagreed with concerns that the government’s tax-cutting budget would boost long-term economic growth.

On Sunday, Truss defended his plan and gave no sign of backing down, although he said it was Kvarteng’s decision to propose tax cuts for the wealthiest and could distance himself from the chancellor at the first sign.

Gilts, Sterling and the FTSE250

At the end of a tumultuous week, many pension funds were still shedding positions to meet collateral requirements, and some were asking their money management companies to provide them with cash, sources told Reuters on Friday. “The question is what happens when the Bank of England exits this market?” Mercer’s Brundrett added that there is a window of opportunity for pension funds to get enough cash together to bolster their collateral positions.

“If it continues like this by the end of the day (Monday), we will be in serious trouble,” a fund manager at a UK corporate pension scheme told Reuters.

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

BlackRock, another large LDI manager, told clients on Wednesday that it would not allow them to fill the collateral needed to keep their positions open, according to a note from BlackRock seen by Reuters.

BlackRock said in an emailed statement on Friday that it had reduced leverage in the funds and had not stopped trading with them.


The potential for stress to spill over into pension funds and across Britain’s financial industry was real. If the LDI funds defaulted on their positions, the banks that organized the derivatives would also be absorbed.

The massive strain on a major economy’s financial system sent global ripples, with even safe-haven US Treasuries and highly rated German bonds taking a hit. Atlanta Fed President Raphael Bostic warned on Monday that events in Britain could lead to greater economic stress in Europe and the United States.


Although the BoE intervention sent the yield on 30-year bonds back to September 23 levels and eased fears of an immediate crisis, lowering yields sharply, fund managers, pension experts and analysts say Britain is far from out of the woods.

No one knows how much the schemes will have to sell and what will happen after the BoE stops buying bonds on October 14.

Britain’s central bank is now in the unenviable position of delaying its bond-selling plan and resulting in monetary easing while simultaneously tightening interest rates.

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

“The concern is that the market sees this as something to test and I don’t believe the Bank will want to set that precedent. It continues to leave long gold vulnerable,” said Orla Garvey, fixed income manager at Federated Hermes. .


Investor confidence is shaken, not only in Britain.

“The situation in the UK is quite serious because 30% of mortgage loans are going to variable interest rates,” said billionaire investor Stanley Druckenmiller.

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

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

Meanwhile, demand for the US dollar in currency derivatives markets rose to the highest level since the height of the COVID-19 crisis in March 2020, as market turmoil sent investors scrambling for cash.

Billionaire Ken Griffin, founder of Citadel Securities, one of the world’s largest marketing companies, is worried.

“This is the first time in a very long time that we’ve seen a major developed market 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; Edited by Elisa Martinuzzi and Alexander Smith

Our standards: Thomson Reuters Trust Principles.

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