LONDON, Oct 11 (Reuters) – UK pension schemes are rushing to raise hundreds of billions of pounds to bolster derivatives positions before the Bank of England asks for time for support to keep them afloat.
The Bank of England plans to stop buying bonds on Oct. 14, leaving pension schemes confused to meet a collective cash call estimated at at least £320 billion ($355 billion) without a last resort.
The central bank made its fifth attempt on Tuesday in just over two weeks to try and restore order to markets after a rise in interest rates on Sept. 28 threatened to overwhelm pension plans loaded with leveraged derivatives.
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Pension funds have spent the past two weeks trying to raise money by selling UK Treasuries, or Treasury bonds, indexed and corporate bonds, but the task of raising money is intensifying, sources say.
To add to the pain, providers of so-called liability-driven investment strategies (LDI) are demanding more cash to support new and older hedging positions.
The cash buffers now needed are about three times larger than previously requested, according to four advisers who advise pension plans, as market players seek larger buffers against larger fluctuations in bond prices.
“This week, with the gold market not fully calming down, many (of) schemes are now looking at this and saying we should actually do a little more and so there is renewed action to transfer even more collateral,” said Steve Hodder, a partner at pension advisors Lane Clark & Peacock.
While estimates of how much pension funds need to sell vary, they run into the hundreds of billions of pounds, and it’s unknown how many funds have already raised in cash. Some schemes will also reduce their overall LDI exposure if they can’t meet collateral requirements, consultants say.
Tuesday’s latest BoE intervention focused on buying indexed bonds, a much smaller market than government bonds, dominated by pension funds and which saw another significant sell-off this week.
The Pensions and Lifetime Savings Association on Tuesday called on the BoE to consider continuing its emergency bond-buying program until Oct. 31 “and possibly beyond.”
Speaking in Washington later today, BoE Governor Andrew Bailey said: “And my message to the affected funds and all the companies involved in managing those funds. You have three days now. You have to get this done. get.” SCRAMBLE FOR CASH
LDI helps schemes match their liabilities – what they owe members – with assets. Pension funds had previously put in cash to withstand a rise in government bond yields from 100 to 150 basis points — normally a huge safety net, but that has been wiped out by some of the most volatile days on record.
Those collateral buffer requirements rose to 300 basis points last week, consultants and pension industry experts said. Some schemes have even been asked for 500 basis points this week amid more jumps in bond yields, though that amount remains rare.
The battle for cash in the £1.6 trillion LDI industry, which became hugely popular under UK defined benefit plans in a decade of low interest rates, is forcing pension funds to ditch government and corporate bonds and even less liquid assets, such as to leave real estate. and 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 Tuesday it would make additional liquidity available to its LDI counterparties as part of the BoE’s Oct. 10 launch of an expanded repo facility. The facility allows schemes to park more assets, including low-rated corporate bonds, in exchange for cash.
HOW MUCH MORE?
Nikesh Patel, Head of Client Solutions at Kempen Capital Management, calculates that pension plans would collectively need to deposit £160 billion in cash as collateral for any potential 100 basis point increase in returns.
He estimates that following further yield volatility over the past two days and in light of the sector’s higher collateral requirements, the total cash to be placed now could be £320 billion or more.
“We’re definitely not there,” he said, referring to whether the funds were getting close to the money needed by selling assets. He described last week as “one of the biggest ever for sell orders. You’re seeing more sales this week.”
The increased need for collateral was driven by pressure from regulators led by the BoE to prevent further pressure on the system, said Hemal Popat, investment partner at Mercer.
He estimates that pension funds could sell assets totaling around £300 billion if they adjust their hedging positions, although it’s not clear how much they’ve already sold. He estimated that £100 billion could come from gilts and the rest from assets such as global credit, global equities and asset-backed 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 weak and yields were likely to rise further whether the BoE extended its bond purchases on Friday or not, said Craig Inches, Head of Rates and Cash at Royal London Asset Management.
“The bottom line is that many schemes need to rebalance their portfolios,” he said. “That doesn’t stop and it takes time.”
($1 = 0.9007 pounds)
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Reporting by Tommy Reggiori Wilkes and Carolyn Cohn, editing by Sinead Cruise and David Evans
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