The Bank of England (BoE) announced this morning that it will widen the scope of its daily Gilt purchase operations to also include purchases of index-linked Gilts, as if continues to monitor developments in financial markets very closely in light of the significant asset repricing of recent weeks.
This enhancement to the Bank’s operations will be in effect from today (11 October 2022) until 14 October 2022 alongside its existing daily conventional Gilt purchase auctions, it said.
For the past couple of weeks the BoE has worked with UK authorities to address risks to the resilience of liability-driven investment (LDI) funds arising from volatility in the long-dated government bond market.
On 28 September, the Bank announced that, in line with its financial stability objective, it would make temporary and targeted purchases of Gilts to help restore market functioning and reduce any risks from contagion to credit conditions for UK households and businesses.
As previously announced, the Bank plans to end these operations and cease all Gilt purchases on Friday 14 October.
On 10 October, the Bank announced additional measures to support market functioning and an orderly end to its Gilt purchase scheme. These included the launch of a Temporary Expanded Collateral Repo Facility (TECRF) through which banks would be able to help to ease liquidity pressures facing their client LDI funds through liquidity insurance operations, and the expansion of the scale of its remaining Gilt purchase auctions.
The purpose of these operations is to enable LDI funds to address risks to their resilience from volatility in the long-dated Gilt market, the Bank said.
LDI funds have made substantial progress in doing so over the past week. However, the beginning of this week has seen a further significant repricing of UK government debt, particularly index-linked Gilts. Dysfunction in this market, and the prospect of self-reinforcing ‘fire sale’ dynamics pose a material risk to UK financial stability.
Hence the Bank widening its daily Gilt purchase operations to include purchases of index-linked Gilts, it added.
These additional operations will act as a further backstop to restore orderly market conditions by temporarily absorbing selling of index-linked Gilts in excess of market intermediation capacity. As with the conventional Gilt purchase operations, these additional index-linked Gilt purchases will be time-limited and fully indemnified by HM Treasury. The Bank has also consulted with the Debt Management Office.
Too late?
“The Bank of England’s decision to buy index-linked Gilts today has arguably come a week late. With UK pension schemes holding approximately two thirds of their liabilities which are sensitive to both interest and inflation rates, the majority of the liability-hedging programmes would be made up of index-linked Gilts,” said Arif Saad, co-head of UK investment strategy at Van Lanschot Kempen.
“The slower doom spiral we have seen in the past week has been a function of pension schemes selling their index-linked Gilts to raise cash to fund LDI recapitalisation events. The Bank of England becoming a purchaser of these sales should slow the tide, but with yield movements in the last week, the question is: will this be enough to shore up the market?” he added.
As the Bank has acknowledged, the historically high speed of repricing and market moves were unprecedented and it has also recognised that, in some cases, even prudent risk-management practices or regulatory stress tests were insufficient to manage the resulting volatility. This turbulence put significant stress on the Gilt market and resulted in rapid and spiralling collateral calls for some defined benefit funds using LDI strategies.
The Pensions and Lifetime Savings Association (PLSA) believes the Bank’s early intervention was generally effective, with far lower levels of Gilts being purchased than provided for – around £5bn out of a facility of up to £65bn. Recent days have, however, shown that market confidence remains low.
The PLSA has been supporting its members and engaging with regulators to help manage the situation. “We continue to encourage all pension funds and service providers to use this period to take further steps to re-balance portfolios and ensure necessary measures are in place to protect their strategies in uncertain times,” it stated.
“Going forward, we will continue to work with relevant authorities to understand any lessons learned and to ensure the LDI market – which in general has provided UK schemes and UK PLC with significant amounts of stability over the last 20 years – remains resilient and effective. LDI is intended as a tool to manage risk and ensure pensions are paid when due with minimum volatility for the funders of the scheme,” the association continued.
PLSA analysis suggests that the majority of pension funds used LDI in a prudent manner and with sensible arrangements to meet calls for collateral if normal market conditions, or those under prudent stress scenarios, prevailed. Over the past couple of weeks, pension funds also have taken steps to further strengthen their financial resilience.
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