LDI funds sold £23bn of gilts during market turmoil

Speaking at a Treasury Committee hearing on January 16, the Bank of England governor said the sales figure, which occurred between the last week of September up to middle of October, “doesn’t tell the losses” of assets registered by defined benefit schemes.

“One of the reasons I don’t have [losses] numbers is that pensions have quite a distinctive form of accounting. So my understanding is that pension funds themselves were not recording a decline in their net liabilities, and that is due to the accounting framework,” Bailey said.

The BoE announced a £65bn bond-buying programme in September in an attempt to stabilise markets.

The segregated funds were not forced sellers — they did sell towards the end of our window, but they were not forced sellers in that sense. It was the pooled funds who were the forced sellers

Andrew Bailey, Bank of England

The collateral calls led, in some cases, to the fire sale of assets by DB schemes, or trustees entering into emergency arrangements to secure funds to enable them to meet these calls. In other cases, hedge ratios were reduced to avoid contracts terminating.

In November, the Work and Pensions Committee was told that around £500bn in assets were “missing” following the crisis, while the Pension Protection Fund warned that the true extent of the turmoil was still unknown.

Bailey reiterated that the BoE intervention was determined by the lack of ability of LDI pooled funds to receive the liquidity needed from schemes to rebalance in a short period of time.

He explained that the LDI market is divided into segregated funds, which comprise 85 per cent of the market, and pooled funds, which make up the remainder 15 per cent.  

While in pooled funds the assets of a large group of schemes are invested together, segregated mandates are specific to a single pension scheme.

“The segregated funds were not forced sellers – they did sell towards the end of our window, but they were not forced sellers in that sense. It was the pooled funds who were the forced sellers,” he said.

Bailey explained that the pooled funds have a limited liability structure, which is essential as no “pension fund is going to take on the liabilities of every other pension fund”.

“The problem with that limited liability structure [...] is that they had to therefore have triggers in them, because if a single pension fund said ‘I’m not going to meet that collateral call, I rather walk away given the shock’, the pooled fund has to handle it given it has got other pension funds, and they do that by having triggers,” which leads to the sale of assets, he said.

Regulators missed the point

Bailey revealed that the work carried out by the BoE’s Financial Policy Committee on the non-bank financial system, which has included specific work on LDI leverage and liquidity in 2018, did not include the pooled funds.

“The work we initiated in 2018-19 with the Pensions Regulator focused on the 85 [per cent] and that was a judgment that was made [at the time, because] they are bigger, much bigger,” he said.

“We must hold our hands up and say by looking at the 85 [per cent], the 15 [per cent] remained relatively obscure,” he added.

Sam Woods, deputy governor for prudential regulation at the BoE and chief executive of the Prudential Regulation Authority, told the MPs that the central bank is satisfied with the measures introduced after the market turmoil.

TPR published guidance for schemes on November 30, which sets out the watchdog’s expectation that liquidity buffers be maintained across pooled and leveraged LDI mandates.

Sterling-denominated LDI funds across Europe have now secured an average yield buffer of around 300 basis points to 400bp, according to the Central Bank of Ireland and Luxembourg’s Commission de Surveillance du Secteur Financier.

This buffer refers to the level of yield adjustment on long-term gilts from which an LDI fund is insulated, or may absorb, before its capital reserves are depleted. LDI funds trading in the UK are based exclusively in the Republic of Ireland and Luxembourg.

Woods said: “We are in a stopgap situation. TPR, with the assistance of the [Financial Conduct Authority], and crucially the regulators from other countries that actually regulate the funds that we’re talking about here, have put in place [...] an expectation that the level of resilience which was built up – during the window that the bank’s operation was running – will be maintained.”

However, he added that “although it is great that we’ve got the stopgap, the real test here will be if those steady state regulations do the job”.