LONDON (Reuters) – UK pension plans are racing to raise hundreds of billions of pounds to shore up derivatives positions before the Bank of England asks for time to back them up to keep them afloat.
The Bank of England plans to halt bond buying on October 14, leaving pension plans scrambling to meet a collective cash demand estimated at at least 320 billion pounds ($355 billion) without a buyer of last resort.
The central bank on Tuesday made its fifth attempt in just over two weeks to try to restore order in the markets, after a surge in yields on Sept. 28 threatened to flood pension programs loaded on leveraged derivatives.
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Pension funds have spent the past two weeks trying to raise money by selling UK government bonds, or government bonds, index-linked bonds and corporate bonds, but the fundraising task is ramping up, sources say.
Compounding the pain, providers of so-called liability-driven investment strategies (LDIs) are demanding more funds to support new and old hedge positions.
Required cash reserves are now about three times greater than previously required, according to four consultants advising pension plans, as market players seek greater cushions against large swings in bond prices.
“This week with the gold market not completely calming down, a lot (of the charts) are now looking at this and saying we really need to do more, so there is a rolling action to get more collateral,” said Steve Houder. Partner in Pension Consultants Lynne Clark and Peacock.
While estimates vary of how much pension funds need to be sold are in the hundreds of billions of pounds, it is not known how much cash they have actually raised. Advisers say some schemes will also reduce their overall LDI exposure if they cannot meet the additional requirements.
The Bank of England’s latest intervention on Tuesday was aimed at buying index-linked bonds, a much smaller market than government bonds, dominated by pension funds and which suffered another big sell-off this week.
The Pensions and Lifetime Savings Association on Tuesday called on the Bank of England to consider continuing its emergency bond purchase program until October 31 “and possibly beyond”.
Speaking in Washington later in the day, Bank of England Governor Andrew Bailey said: “And my message is to the funds involved and all the companies involved in managing this money. You have three days left now. You have to get this done.” The scramble for cash.
LDI helps schemes match their liabilities — what they owe to members — with assets. Pension funds previously offered cash to counter a move in government bond yields of 100 to 150 basis points — usually a huge safety net, but it has been wiped out on some of the most volatile days ever.
Advisers and experts in the pension industry said additional security demands rose to 300 basis points last week. 500 basis points were requested from some charts this week amid further jumps in bond yields, although that amount remains rare.
The scramble for liquidity in the 1.6 trillion pound LDI industry, whose popularity has soared among Britain’s defined benefit plans during a decade of low interest rates, is forcing pension funds to dump government and corporate bonds, and even out of less liquid assets such as property. and private equity. Columbia investment manager Threadneedle said on Tuesday it had suspended trading in £453m of its approved CT UK real estate investment trust and its cash-recovery feeder fund.
In another indication of market pressure, Barclays said on Tuesday that it will provide additional liquidity to its LDI peers as part of the Bank of England’s October 10 launch of its expanded repo facility. This facility allows schemes to park more assets including low-rated corporate bonds for cash.
How much more do you want?
Nikesh Patel, head of client solutions at Kempen Capital Management, calculates that pension plans collectively need to deploy £160 billion of cash as collateral for each potential 100 basis point move in returns.
It is estimated that after more fluctuations in yields in the past two days and in light of the high collateral requirements of the industry, the total cash to be deployed now could reach 320 billion pounds or more.
“We’re definitely not there,” he said, referring to whether the funds were close to raising needed liquidity by selling assets. He described last week as “one of the biggest selling orders ever. You’re seeing more sales this week.”
Himal Bhubat, Partner, Investments in Mercer, said the increased need for collateral was prompted by pressure from regulators led by the Bank of England to prevent further pressures on the system.
He estimates that pension funds could sell assets totaling around £300 billion as they adjust hedge positions, although it is not clear how much they may have actually sold. He estimated that 100 billion pounds could come from government bonds and the rest from assets such as global credit, global stocks and asset-backed securities.
The Bank of England declined to comment further.
The leading LDI providers, Legal & General Investment Management and Insight Investment, did not respond to requests for comment.
Liquidity in government bond markets has remained weak, and yields are likely to rise further whether or not the Bank of England extends bond purchases on Friday, said Craig Inches, head of rates and cash at Royal London Asset Management.
“The bottom line is that a lot of schemes need to rebalance their portfolios,” he said. “This is not going to stop and it will take time.”
(dollar = 0.9007 pounds)
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(Covering) Written by Tommy Reggiore Wilkes and Carolyn Cohn; Editing by Sinead Cruz and David Evans
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