LONDON, Oct 11 (Reuters) – Britain’s pension schemes are trying to raise hundreds of billions of pounds to shore up derivatives positions before the Bank of England calls for time for support to keep them afloat.
The Bank of England plans to stop buying bonds on October 10th. 14, making pension schemes scramble to meet a collective cash call estimated at at least £320 billion ($355 billion) without a buyer of last resort.
The central bank on Tuesday made his fifth attempt in just over two weeks to try to restore order to markets after returns on 11.28 threatened to overwhelm pension schemes that had been loading on leveraged derivatives.
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Pension funds have spent the last two weeks raising money by selling UK government bonds or gilts, index-linked and corporate bonds, but the task of raising funds is increasing, sources say.
To make matters worse, providers of so-called liability-driven investment strategies (LDI) are demanding more cash to support new and legacy hedging positions.
According to four advisors who advise on pension schemes, the cash buffers now required are about three times larger than previously required as market participants seek larger buffers against larger swings in bond prices.
“This week, with the Gilt market not fully calming down, many (systems) are looking at this and saying we actually need to do a little bit more and so there is renewed action to provide even more collateral said Steve Hodder, a partner at pensions consultancy Lane Clark & Peacock.
While estimates vary as to how much pension funds will need to sell, they are in the hundreds of billions of pounds and it is unknown how much money has already been raised in cash. Some schemes will also reduce their overall LDI exposure if they can’t meet collateral requirements, advisers say.
The latest BoE intervention on Tuesday was aimed at buying index-linked bonds, a far smaller market than gilts dominated by pension funds that has suffered another sharp sell-off this week.
The Pensions and Lifetime Savings Association urged the BoE to do so on Tuesday consider moving on its emergency bond-buying program through 10.31 “and possibly beyond”.
BoE Governor Andrew Bailey said in Washington later in the day: “And my message to the funds involved and all the firms involved in managing those funds. You now have three days left. You must do this. ” CROSS ON CASH
LDI helps systems match their liabilities – what they owe members – to assets. Pension funds have historically provided cash to withstand a 100 to 150 basis point move in government bond yields – normally a huge safety net but one that has been shattered by some of the most volatile days on record.
Those safety buffer requirements rose to 300 basis points last week, fixed income advisors and experts said. Some systems have even been asked for 500 basis points this week on further bond yield jumps, although that amount rarely stays.
The struggle for cash in the £1.6 trillion LDI industry, which rose in popularity among Britain’s defined benefit schemes in a decade of low interest rates, is forcing pension funds to sell off government and corporate bonds and divest even from less liquid assets such as property and private equity. Investment manager Columbia Threadneedle said on Tuesday it had suspended trading in the £453million CT UK Property Authorized Investment Fund and its feeder fund to restore liquidity.
In another hint of market stress, Barclays said on Tuesday it would provide additional liquidity to its LDI counterparties as part of the BoE October 2020. 10 Introduction of an enhanced repo facility. The facility allows schemes to park more assets, including low-rated corporate bonds, for cash.
HOW MUCH MORE?
Nikesh Patel, Head of Client Solutions at Kempen Capital Management, calculates that pension schemes need to pledge a total of £160 billion in cash as collateral for every potential 100 basis point move in yields.
He estimates that after further volatility in returns over the past two days and given the industry’s heightened security requirements, the total cash now required to be deposited could be £320bn or more.
“We’re definitely not there,” he said, referring to whether the funds were close to raising the necessary cash through asset sales. He described last week as “one of the biggest sell orders of all time. You see more sales this week.”
The increased need for collateral has been driven by pressure from BoE-led regulators to prevent further strains on the system, said Hemal Popat, partner, investments at Mercer.
He estimates pension funds could sell around £300 billion in assets if they adjust their hedging positions, although it’s not clear how much they may have already sold. He estimated £100 billion could come from gilts and the rest from assets such as global credit, global equities and asset-backed securities.
The BoE declined to comment further.
Leading LDI providers Legal & General Investment Management and Insight Investment did not respond to requests for comment.
Liquidity in government bond markets remained low and yields are likely to continue rising whether or not the BoE extends its bond purchases on Friday, said Craig Inches, head of rates and cash at Royal London Asset Management.
“The bottom line is that many systems need to rebalance their portfolios,” he said. “This will not stop and will take time.”
($1 = 0.9007 pounds)
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Reporting by Tommy Reggiori Wilkes and Carolyn Cohn, editing by Sinead Cruise and David Evans
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