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Pension stability questioned for the first time

By Alistair Kellie
29 September 2022

By Alistair Kellie

Unprecedented”, “dire” and “alarming”.  These were just some of the reactions from our clients in the pensions industry yesterday morning, before the Bank of England intervened with a £65 billion package to spend £5 billion a day for 13 days, citing a ‘material risk to UK financial stability’.

The day started with an article in The Times which reported that some defined benefit (‘DB’) pension funds were facing cash calls on billions of pounds a day to meet collateral requirements on liability-driven investment strategies.  By mid-morning, the yield on these long-dated bonds had jumped by 1.25 percentage points, passing the 5 per cent mark for the first time in 20 years. A mass of sell-offs pushed down further the price of gilts held by funds as assets, requiring them to stump up even more cash.

This mattered because DB pension schemes hold about £1.5 trillion in assets, of which around half is in gilts which have hedged their ability to make future payments — so-called liability-driven investment (‘LDI’) strategies, which are very sensitive to fast-moving gilt yields.  These assets are supposed to be the safe haven as schemes de-risk from equities. 

At 11am, the Bank announced that it was to suspend a programme to sell gilts, known as quantitative tightening, until the end of October as it sought to ‘restore market functioning and reduce any risks from contagion to credit conditions for UK households and businesses’.   The intervention sought to buy time to prevent a vicious circle in which pension funds would have to sell gilts immediately to meet demands for cash from their creditors.

By mid-afternoon, Sky News’ Ed Conway tweeted that the Bank of England was ‘responding to a “run dynamic” on pension funds – a wholesale equivalent of the run which destroyed Northern Rock’.  Had they not intervened, Conway wrote, ‘there would have been mass insolvencies of pension funds by THIS AFTERNOON’.

Whilst necessary, this is not supposed to happen in the sleepy world of pensions.  Pensions have previously made the front pages with publicised scandals such as Maxwell and his fraudulent appropriation of the Mirror Group pension fund, or issues around the BHS pension scheme following the actions of Philip Green. But these were individual cases, not widespread systemic issues.

Savers shouldn’t have to doubt the ability of their pension fund to pay out their hard-earned benefits over the course of their retirement.  As part of their fiduciary duties, Trustee Boards of schemes and their pensions offices are always looking to mitigate risk and ensure the long-term ability of the funds to pay out to their members.

In the short term it appears that the intervention has worked, as UK government bond markets recovered sharply after the announcement.  According to Tradeweb, 30-year gilt yields fell 1 percentage point to 4 per cent — their biggest drop for any single day on record, and ten-year yields slipped to 4.1 per cent from 4.59 per cent.

However, economists have warned that the injection of billions of pounds of newly minted money into the economy could fuel inflation.

Looking ahead, the Bank of England will hold daily auctions to buy up to £5 billion of gilts with a maturity of at least 20 years, until 14 October.  Then on 3 November, the Bank is likely to increase the base rate into stem rising inflation followed by a second ‘mini-Budget’ from the Chancellor on 23 November.

All of this uncertainty comes at a time when more and more people are dipping into their pensions to cope with the cost of living crisis with predictions that this trend will increase over the coming months as soaring food and energy prices put pressure on pensioner incomes.

Everyone involved with the pensions sector will hope that stability will return as soon as possible.