It has been a week like no other for the pensions industry.
The UK and global macroeconomics are important and will continue to be, but the huge focus of the week for defined benefit pension funds has been on liability-driven investment (LDI) funds used to hedge risk. Put very simply, pension funds with leveraged hedging strategies (a very common approach) have faced large collateral calls to post cash at short notice due to the sharp rise in gilt yields. The Bank of England was forced to step in and provide liquidity by buying gilts, which it has said it will do until 14 October.
I'll avoid political comment but summing up where we stand on 30 September:
- There have been some extraordinary impacts for pension funds depending on the extent of hedging, leverage, and ability to post collateral. For some these have been very positive for the time being at least (likely to be those unhedged or with low hedging). As a matter of governance and common sense those in this situation need to consider whether and how to respond in short order. This might include the extent to which you want to/can take advantage given ongoing uncertainty, and the implications for your journey plans. All those who have faced uncomfortable situations need to take stock and consider whether to adjust their strategies and any implications for the long term.
- There has been a great deal of hard work across the industry to manage the extreme circumstances including a number of sponsors stepping in with emergency loans for liquidity. There remain interesting questions about the structural strains in evidence this week.
- There will need to be some very close evaluation of the assumptions and rationale underpinning LDI strategies and integrated risk management more generally - particularly topical given the current consultation on the development of the statutory funding regime and the expected consultation on the Regulator's code on the matter.
- There remains a huge amount of uncertainty, particularly given that as it stands the Bank of England's intervention is time-limited.
The next few months are going to be very interesting
It all stems from a dramatic collapse in the price of these government bonds, called gilts