Analysis: Trustees and their advisers explain how schemes are reacting to liquidity constraints that erupted after the government’s “mini” Budget on September 23.
Markets would quickly digest the contents of a budget that pledged sweeping, unfunded tax cuts. The sterling slumped to a 37-year low against the dollar.
Gilt yields began to rise, but the immediate impact on pension schemes had yet to reveal itself — at least in public. The Budget’s sole pensions announcement committed defined contribution reforms to spur scheme investment in science and technology.
The suitability of defined benefit pension scheme investments would come under scrutiny in the coming days. Gilts, normally a safe haven for investors, began to bleed. Having sat below 4 per cent prior to the Budget, the yield on 30-year gilts leapt to 4.99 per cent on September 27.
We did have an employer yesterday asking about putting in contributions to take advantage of the current market
Rob Dales, Atkin
Managers of schemes’ liability-driven investments — an investment tool that has been in the market for nearly two decades — issued collateral calls as gilt yields spiked.
This triggered a liquidity crisis for schemes, which would sell down their gilts along with other assets including property and multi-asset credit, in a race to meet these calls. The Bank of England decided to act.
‘Schemes will be better prepared’
On September 28, the central bank launched a £65bn gilt-buying programme that would last until October 14, later expanding it to include index-linked bonds. This prompted a fall exceeding 100 basis points in the 30-year gilt yields that day.
BoE deputy governor for financial stability Sir Jon Cunliffe would later tell MPs that some LDI investments would have been rendered worthless without the central bank’s intervention.
Yields have resumed their ascent, with the yield on 30-year gilts pushing through 5 per cent on October 12, the day after BoE governor Andrew Bailey confirmed that the gilt-purchasing programme would not be extended beyond its deadline.
Bailey’s refusal to prolong the BoE’s support met with opposition from the Pensions and Lifetime Savings Association, which has called for the gilt-purchasing programme to continue until at least October 31, when the government’s next fiscal event is scheduled to take place.
“The short term of the support has not allowed pension funds the time to reposition holdings of long-term assets that are not liquid,” warned Capital Cranfield professional trustee Mark Hedges.
Not all trustees objected to the central bank shutting the door on further support.
“He’s upping the pressure on funds to act now and act substantially, thus trying to get the biggest bang for his buck,” Zedra managing director Richard Butcher told Pensions Expert.
“Let’s not forget, most of what he said he’d make available has not been drawn down. The fact it hasn’t been accessed implies funds have things under control, but cash calls are coming fast and furious at the moment.”
One pensions consultant, who did not wish to be named, told Pensions Expert that they had seen a lot of increases to collateral calls. One small scheme had seen their cash call rise 25 per cent from 9am to 2pm on October 11, the consultant observed.
“The big thing that remains the big story is the speed of the rise in yields,” they said.
“If they raise slowly, that’s fine. They can’t spike again. Schemes will be better prepared, but they can’t be in a position to cope with the rise we had the other day.
“I don’t know what the fund managers will be doing but [I] suspect they’re deeply concerned.”
The BoE's actions, and those of its governor, are under intense scrutiny. When asked what he would do if he were still pensions minister, during a PLSA panel on October 12, LCP partner Sir Steve Webb said: “I would sack Andrew Bailey.”
Time to buy more LDI?
The Pensions Regulator estimates that at the end of 2018, schemes had around 2,400 LDI agreements in place. It expects this to have grown to around 3,000 deals by the end of 2021.
Of these circa 3,000 agreements, it expects around 60 per cent to be in pooled funds and 40 per cent segregated. Given there are just over 5,000 DB schemes in the UK, this means that about 60 per cent of pension schemes have LDI, TPR said.
As well as gilts, schemes have sold assets including property and multi-asset credit in the search for liquidity. At least one has even sold equities.
Pinsent Masons pensions lawyer and trustee Robin Ellison told Pensions Expert that one of the schemes he has responsibility for sold a small portion of equities on the morning of October 12 to meet collateral calls.
However, Ellison added that, in his view, the worst of the turmoil has passed.
Indeed, the longer-term funding levels of most DB schemes have improved in response to the rise in gilt yields. According to TPR, the value of scheme liabilities have dropped by up to 50 per cent, depending on the scheme.
TPR moots LDI power of attorney as Bailey rules out more support
The Pensions Regulator has called on defined benefit pension schemes to review their liquidity, liability hedging and governance processes, suggesting that managers of their liability-driven investments could be granted power of attorney over some assets to quicken trading.
Schemes are discussing approaching employers for an advance on contributions in order to preserve their hedging ratios and, ultimately, lock in their healthier funding positions. Zedra’s Butcher has floated the idea with one employer.
Atkin professional trustee Rob Dales, meanwhile, told Pensions Expert that one of his schemes had been approached by its sponsoring employer — a small family business — on October 11.
“We did have an employer yesterday asking about putting in contributions to take advantage of the current market, and buying more LDI through employer contributions rather than reshaping the assets,” he said.
Additional reporting by Maria Espadinha
