#457
Gilty As Charged
Published:
Oct 03, 2022
Author:
Sarah Parsons Wolter
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Gosh what a month! Between the passing of the Queen (God save the King), the British Pound sell-off (it’s called soccer now…), and the possibility for an emergency rate hike by the Bank Of England, the last thing the UK really needed this month was Grandma and Grandpa’s pension to be wiped out in a systemic financial meltdown. But that’s what the country came very close to this week, with the central bank being forced to step in as the buyer of last resort to help curb an LDI driven sell off that almost broke the pension market.
So what exactly is LDI and why does it matter? Put simply, Liability Driven Investing is an approach that focuses the investment policy and asset allocation decisions on matching the current and future liabilities of a pension plan, and as such represents 40% of the UK institutional asset management market and two-thirds of GDP i.e. it’s massive.
The rapid sell off in long dated Gilts meant that counterparties made margin calls on pension funds who then had to liquidate more Gilts, further spiraling price action into free fall. The BOE, which was supposed to start selling bonds to unwind Quantitative Easing as of next week, was forced to reverse course and temporarily start buying bonds to curb a Lehman Brothers style market contagion.
So…14yrs and 16 days since Lehman collapsed, and 10 years since FinTech Collective started investing in how money flows through the world, we’ve just had another good reminder that there is still a lot for entrepreneurs (both tradfi and defi ) to fix in the system. Let's hope the image of King Charles III appearing on Sterling gives it more than a cursory redecoration!
Gilty As Charged
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Industry News
The reason the BoE is buying long gilts: an LDI blow-up - We all know the story about why short-end rates have soared in the UK. But what about the long-end? Well, basically pension plans appear to have been caught in doom-loop of margin calls on interest rate derivatives that forced them into dumping longer-maturity UK gilts, and spurred the Bank of England into intervening this week. Read more
BlackRock threatened to halt trading at height of UK market tumult - In a memo sent on Wednesday morning, BlackRock told clients using its liability-driven investing strategies that it would freeze “funds more at risk of assets being exhausted” and move the assets to cash. One professional trustee said the actions left pension schemes potentially unable to take steps to protect their members. Read more
Europe faces ‘severe risks’ to financial system, regulators warn - The European Systemic Risk Board, which is responsible for monitoring and preventing dangers to the region’s financial system, issued the alert after meeting last week and deciding the energy crisis triggered by the war in Ukraine had put the financial system in a precarious position. This is the first “general warning” about risk the ESRB has issued since its creation in 2010 on the eve of the eurozone sovereign debt crisis. Read more
The Problems Facing the Gilt Market Aren't Unique to the UK - The turmoil draws attention to the fragility of government bonds around the world when they are not, one way or another, being manipulated by governments and central banks. Read more
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