BoE expands measures to protect schemes from market turmoil

The central bank announced on September 28 a £65bn bond-buying programme in an attempt to stabilise markets, after falling government bond prices prompted collateral calls for defined benefit schemes.

In a statement on October 10, the BoE said it is introducing three additional measures to “support an orderly end of its purchase scheme”, which is set to end on October 14.

The central bank will “stand ready to increase the size of its daily auctions to ensure there is sufficient capacity for gilt purchases” ahead of the last day of the programme.

The bank will continue to work with the UK authorities and regulators to ensure that the LDI industry operates on a more resilient basis in future

Bank of England

So far, the BoE has carried out eight daily auctions, offering to buy up to £40bn, and has made around £5bn of bond purchases.

“The bank is prepared to deploy this unused capacity to increase the maximum size of the remaining five auctions above the current level of up to £5bn in each auction,” it noted.

The maximum auction size will be confirmed each morning and was set at £10bn for the operation on October 10.

Extra support for LDI investors

LDI is a risk management tool used to protect schemes from adverse movements in interest rates and ensuring that funding levels do not deteriorate when interest rates fall.

Pension schemes will have plans in place so that if interest rates rise, they are required to post collateral, and typically conduct a stress test against a 1 per cent rise in long-term gilt yields.

While schemes have generally coped with the additional capital calls required, an increase of gilt yields to 4 per cent went beyond the contingency plans that most schemes had in place, creating stress within the financial system and dictating the need for the BoE intervention.

To support schemes, the central bank announce the launch of a temporary expanded collateral repo facility, which will “enable banks to help to ease liquidity pressures facing their client LDI funds through liquidity insurance operations”.

Under this operation, which will run until November 10, the BoE will accept collateral eligible under the Sterling Monetary Framework, including index-linked gilts, and also a wider range of collateral than normally eligible under the framework, such as corporate bond collateral, it said.

The central bank also stated that it will “stand ready” to support “further easing of liquidity pressures facing LDI funds” through its regular indexed long-term repo operations.

This is a permanent facility that “will provide additional liquidity to banks against SMF eligible collateral, including index-linked gilts, and so support their lending to LDI counterparties”.

Liquidity is also available through the BoE’s new permanent short-term repo facility, launched last week, which offers an unlimited quantity of reserves at bank rate each Thursday, it added.

LCP partner Steve Hodder noted the bank’s expanded repo facility "is, on the face of it, a clever mechanism to provide more liquidity to strained investors, to lessen the need for stressed selling of sterling debt".

"The outstanding question is the extent by which pension schemes (particularly smaller ones) will be able to access this as its dependent on how quickly investment managers are able to set up appropriate vehicles."

On October 6, BoE deputy governor for financial stability Sir Jon Cunliffe told MPs that DB scheme investments in some pooled LDI funds would have been rendered worthless without its intervention.

In its market update on October 10, the BoE stated that it “will continue to work with the UK authorities and regulators to ensure that the LDI industry operates on a more resilient basis in future”.