UK Pension Schemes' LDI Strategies Prompted Bank of England's Emergency Intervention in Gilt Market to Shore Up Liquidity

DBRS Morningstar published a commentary discussing the use of liabilities-driven investment (LDI) strategies by UK pension schemes and the emergency intervention of the Bank of England to provide liquidity in the gilt market.

Key highlights include the following:

-- A sharp increase in gilt yields prompted the Bank of England to temporarily purchase up to GBP 65 billion in long-dated government bonds to restore market confidence and to provide liquidity to UK pension schemes that faced significant derivatives margin calls.

-- LDI strategies used by defined benefit pension schemes in the UK caused a doom loop of bond sales that further increased government bond yields and the size of margin calls.

-- Although UK pension schemes’ funding positions have improved with the increase in interest rates, regulators will likely require a reduction in leverage, which ultimately will reduce the average rates of return.

“In DBRS Morningstar’s view, the prompt intervention of the Bank of England has so far averted a liquidity crisis for UK pension schemes that could have unintended consequences for the overall functioning of financial markets, including the untested resolution of a large number of failed variation margin calls”, said Marcos Alvarez, Global Head of Insurance. “DBRS Morningstar will continue to monitor market conditions, particularly those that can pose contagion risk to other financial market participants”.