On the go: Pension fund liability-driven investing techniques are among the systemic risks to the UK’s financial system highlighted by the Bank of England in a new report.
The risks delineated in its July Financial Stability Report include the use of derivatives and repo (a form of short-term borrowing for dealers in government securities). Investors also hold large amounts of leveraged loans, despite the extent to which they can absorb losses in a stressed situation without affecting market prices being uncertain.
Non-bank investors, including pension funds, insurers and investment funds, hold roughly 40 per cent of the total global leveraged loan market.
Around a quarter of the leveraged loans are accessed through collaterised loan obligations. Investment funds typically hold the riskier tranches, which could suffer significant losses in stressful times.
Leveraged loan holdings by open-ended funds are significantly higher than in the period before the financial crisis. Funds held less than $20bn (£16bn) of leveraged loans in 2007, compared with roughly $250bn currently.
As the recent Woodford debacle showed, some funds could face a liquidity mismatch if they were unable to sell these loans quickly in a period of stress, without affecting market prices, and large-scale redemptions from open-ended funds could amplify price falls.
A spokesperson from the Pensions Regulator said: “We have been in discussions with Bank of England about the potential risks from the use of leverage in pension funds’ investment arrangements.
“We are carrying out research into various aspects of pension scheme investment in order to better understand the systemic risks that may arise.”
