LONDON, Oct 11 (Reuters) – British pension schemes are scrambling to raise hundreds of billions of pounds to shore up derivatives positions before the Bank of England calls for support to keep them afloat.
The Bank of England plans to stop buying bonds on October 1[ads1]4, leaving pension schemes to meet a collective cash balance estimated to be 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 to markets, after a rise in yields on September 28 threatened to overwhelm pension schemes that had loaded up on leveraged derivatives.
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Pension funds have spent the past two weeks trying to raise money by selling British government bonds, or gilts, index-linked and corporate bonds, but the fundraising task is intensifying, sources say.
To compound the pain, providers of so-called liability-driven investment (LDI) strategies are demanding more money to support new and older hedging positions.
The cash buffers now required are about three times larger than previously requested, according to four consultants who advise pension plans, as market participants seek larger cushions against larger swings in bond prices.
“This week, with the gilt market not quite calming down, many (of schemes) are now looking at this and saying that we actually need to do a bit more, and so there is renewed action to get even more security,” said Steve Hodder, a partner at pension consultants Lane Clark & Peacock.
While estimates of how much pension funds need to sell vary, they are in the hundreds of billions of pounds, and it is not known how much funds have already collected cash. Some schemes will also cut their overall LDI exposure if they cannot meet collateral requirements, consultants say.
The latest BoE intervention on Tuesday was aimed at buying index bonds, a far smaller market than gilts, dominated by pension funds and which saw another significant sell-off this week.
The Pensions and Lifetime Savings Association on Tuesday asked the BoE to consider continuing its emergency bond-buying program until October 31 “and possibly beyond”.
BoE Governor Andrew Bailey, speaking in Washington later in the day, said: “And my message to the funds involved and all the firms involved that manage those funds. You’ve got three days left now. You’ve got to get this done.” SCRABLE FOR CASH
LDI helps schemes match their liabilities – what they owe members – with assets. Pension funds previously raised money to withstand a 100 to 150 basis point move in government bond yields – normally a huge safety net, but which has been wiped out by some of the most volatile days on record.
Those safety buffer requirements increased to 300 basis points last week, pension industry consultants and experts said. Some schemes have even asked for 500 basis points this week due to multiple jumps in bond yields, although that amount remains rare.
The scramble for cash in the £1.6 trillion LDI industry, which grew in popularity among Britain’s defined benefit schemes during a decade of low interest rates, is forcing pension funds to dump government and corporate bonds and even exit less liquid ones assets such as property. and private equity. Investment manager Columbia Threadneedle said on Tuesday it has suspended trading in the £453m CT UK Property Authorized Investment Fund and its feeder fund to restore liquidity.
In another indication of market stress, Barclays said on Tuesday it would make additional liquidity available to its LDI counterparties as part of the BoE’s launch on October 10 of an extended repo facility. The facility allows schemes to park multiple assets including low-rated corporate bonds in return for cash.
HOW MUCH MORE?
Nikesh Patel, head of client solutions at Kempen Capital Management, calculates that pension schemes collectively need to put up £160bn of cash as collateral for every potential 100 basis point move in returns.
He estimates that after further volatility in returns over the past two days and in light of the industry’s higher demands for security, the total amount of cash could now be £320bn or higher.
“We’re definitely not there,” he said, referring to whether funds were close to raising the necessary cash by selling assets. He described last week as “one of the biggest ever for sell orders. You see more selling this week.”
The increased need for security was driven by pressure from regulators led by the BoE to prevent further strains on the system, said Hemal Popat, partner, investments at Mercer.
He estimates that pension funds could sell a total of around £300bn of assets as they adjust hedging positions, although it is not clear how much they may have already sold. He estimated that £100bn could come from gilts and the rest from assets such as global credit, global equities and collateralised 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 tight and yields were likely to rise further whether or not the BoE extended bond purchases on Friday, said Craig Inches, head of prices and cash at Royal London Asset Management.
“The bottom line is that many schemes need to rebalance their portfolios,” he said. “It’s not going to stop and will take time.”
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Reporting by Tommy Reggiori Wilkes and Carolyn Cohn, editing by Sinead Cruise and David Evans
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