A sharp rise in bond yields has introduced fresh volatility into the UK financial markets, but a repeat of Gilt crisis of September 2022 that threatened the UK pension industry is unlikely, according to industry experts.
UK 10-year Gilt yields rose to 4.93% today, the highest level since 2008, with sterling falling by 0.9% to $1.226 against the dollar, to its weakest since April 2024.
The London Stock Exchange saw a £9.6bn (€11.5b) in cash withdrawals in 2024, making it the worst year on record, as UK borrowing costs have increased following the government’s Budget in October.
As a result, the UK Treasury took the “rare step” of issuing a public comment to reassure the market. It said: “No one should be under any doubt that meeting the fiscal rules is non-negotiable and the government will have an iron grip on the public finances.”
The spokesperson added that UK debt is the second lowest in the G7 and only the Office for Budget Responsibility forecast can accurately predict how much headroom the government has. Anything else is “pure speculation”, the spokesperson said.
Déjà-vu
Steve Hodder, partner in LCP’s investment team, said: “Direct Treasury intervention cast minds back to October 2022, when in the aftermath of the then-UK chancellor of the exchequer Kwasi Kwarteng’s ‘mini budget’ Gilt yields risked spiralling out of control.”
The rapid increase in Gilt yields of September 2022, following Kwarteng’s announcement of large tax cuts, led to pension schemes selling off Gilts and causing a liquidity crunch.
To restore market functioning, the Bank of England temporarily purchased long-dated Gilts from late September to early October 2022.
However, Hodder said two key factors are very different now than in 2022.
First, he said that while yields have hit notable highs, the “magnitude of recent moves is not actually that great”. He said that yields have in fact increased by these sorts of amounts “a number of times over 2024”.
Hodder said: “The movements in October 2022 were far greater and faster.”
The second key factor, according to Hodder, is that institutional investors using LDI approaches to hedge liabilities now typically have far higher levels of liquidity and collateral, reflecting the increased volatility in Gilt markets and new regulatory rules.
He acknowledged that upward pressure on yields remains – both from global factors, and specific supply/demand issues in the UK Gilt market. But “for now at least” he said there aren’t any signs of the LDI landscape starting to crack.
Carl Hitchman, head of UK investment consulting at Gallagher, agreed that the difference between the two events is the rate at which the rates change and how resilient the pension funds now are.
He said: “On the back of the LDI crisis there was a lot of work done by the industry, particularly the pool funds which were in the eye of the storm”.
He added that pension funds are “a lot more resilient now” and Gallagher has been working with its clients and putting collateral waterfalls in place.
“A lot of clients have automated waterfalls in place, so when the call for cash comes the manager has access to various pots of money that they can draw down in a pre-agreed order with a client so there’s no rushing around trying to sort things out at a short notice.”
He said that should yields keep rising, clients might need to top off the waterfall but there is no “sign of panic”.
However, if the yields keep rising materially at a faster rate, then it might start to test the resilience of the new LDI structure that’s in place with pension funds. But he said that pension funds are in a “much better place now than they were back in 2022”.
Fresh volatility but no crisis
David Brooks, head of policy at Broadstone, said the surge in Gilt yields introduces fresch volatility into UK markets, but there “doesn’t seem to be any systemic issues at play.”
He added that LDI funds have been actively managing their cash positions in response to this shifting investor sentiment and market volatility, but agreed with others that there “doesn’t seem to be any systemic issues at play”.
“Improvements to collateral management and waterfall structures since the 2022 yield crisis have significantly strengthened market resilience and ensured schemes are better prepared to handle fluctuations,” he noted.
However, Brooks said that trustees and plan sponsors should continue to focus on monitoring hedging levels, maintaining adequate collateral buffers, and rebalancing portfolios where appropriate.
He added that the higher-yield environment creates opportunities to review de-risking strategies, particularly for schemes that have benefited from improved funding positions.
Brooks said that trustees may also need to review commutation factors to ensure fair value and potentially review covenant positions where sponsor’s borrowing costs have risen.”
Robert Scammell, lead portfolio manager at Van Lanschot Kempen, said that the spectre of a Gilts crisis has been significantly reduced with the new collateral requirements though schemes may still be forced to post collateral as gilts rise, however, he said the prospect of the crisis similar to that in 2022 is “less likely”.
“Whilst it seems unlikely that government bond yields will continue to rise unabated in the way we have seen over the last 3 months, the fiscal challenges of low growth at least in the UK, and an ageing population on top of an already high debt to GDP ratios will not go away overnight,” he explained.
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