Because that's what happens in a bank run...
Fund managers running billions for pension funds faced collateral calls on strategies meant to give them exposure to long-dated assets to help match obligations that can extend decades. The so-called liability-driven investment, or LDI, funds were forced to post more collateral after receiving margin calls when gilt prices collapsed.
The central bank stepped in Wednesday after the calls threatened to push the gilt market into a downward spiral. The BOE had been warned by investment banks and fund managers in recent days that the collateral requirements could trigger a gilt crash, according to a person familiar with the BOE’s deliberations before they stepped in.
“The BOE intervention was required to prevent a vicious cycle becoming even more dangerous for pension funds forced to sell their gilt exposures,” Calum Mackenzie, an investment partner at Aon, said after the BOE intervention. “The market’s swift and significant reaction underlined the big risk faced by pension funds who have had or who could have had their liability hedges reduced.”
Firms including BlackRock Inc., Legal & General Group Plc and Schroders Plc manage LDI funds on behalf of pension clients. The pension firms use them to match their liabilities with their assets, often using derivatives.
The size of the LDI market has exploded over the past decade. The amount of liabilities held by UK pension funds that have been hedged with LDI strategies has tripled in size to £1.5 trillion in the 10 years through 2020, according to the Investment Association. These trades are typically used by defined benefit pension schemes. ...
When yields fall the funds receive margin and when yields rise they typically have to post more collateral. After the spike in gilt yields on Friday and into this week, LDI fund managers were hit by margin calls from their investment banks.
LDI collateral buffers are partly set using historical data to build models based on the likely probability of gilt price movements, according to Shalin Bhagwan, head of pension advisory at DWS Group. The sudden recent surge in gilt yields “blew through the models and the collateral buffers,” he said.
And here is the Financial Times on the BOE’s intervention:
The bank stressed that it was not seeking to lower long-term government borrowing costs. Instead it wanted to buy time to prevent a vicious circle in which pension funds have to sell gilts immediately to meet demands for cash from their creditors. That process had put pension funds at risk of insolvency, because the mass sell-offs pushed down further the price of gilts held by funds as assets, requiring them to stump up even more cash. “At some point this morning I was worried this was the beginning of the end,” said a senior London-based banker, adding that at one point on Wednesday morning there were no buyers of long-dated UK gilts. “It was not quite a Lehman moment. But it got close.” …
“If there was no intervention today, gilt yields could have gone up to 7-8 per cent from 4.5 per cent this morning and in that situation around 90 per cent of UK pension funds would have run out of collateral,” said Kerrin Rosenberg, Cardano Investment chief executive. “They would have been wiped out.”
And FT Alphaville has two very good explainers of the LDI problem, one by Toby Nangle and another by Alex Scaggs and Louis Ashworth, which I have drawn on here. And here is Nangle’s prescient LDI explainer from July. Modern finance made UK pensions vulnerable to runs, and then there was a run on those pensions, and the Bank of England had to step in to buy gilts to save them, because that’s what happens in a bank run.
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