The UK’s finances were plunged into chaos in late September, with the pound falling briefly to an all-time low against the U.S. dollar and a crash in the value of government bonds known as “gilts.”
The uncertainty was sparked by announcements from the new UK government of plans for large unfunded tax cuts intended to spur the British economy and an unfunded cap on energy bills.
The market turmoil had a significant impact for UK defined benefit pension plans, many of which were hours from a potential liquidity crisis.
As government bonds rapidly lost value, pension funds that had invested in widely used leveraged liability driven investment funds (LDI) began facing margin calls from their investment managers, demanding additional collateral to back their leveraged LDI accounts. To meet this call, pension funds started selling off their gilts, thereby sending the price of gilts even lower. Pension funds found themselves caught in a doom loop of forced selling and falling liquidity.
To stem the selloff and prevent a liquidity crisis, the Bank of England intervened, indicating it would purchase government bonds over a two-week period to end the bond market turmoil. In effect, acting as a buyer of last resort.
The UK government has since rolled back the vast majority of its planned tax cuts and is planning to introduce other measures to reassure bond markets of its economic policy. There has also been a change at the UK Treasury with Jeremy Hunt replacing Kwasi Kwarteng as Chancellor of the Exchequer. The Bank of England’s measures, which ended on October 14, have returned some stability. Nonetheless the situation has provided a wake-up call for company pension funds.
Calum Mackenzie, investment partner at Aon, discussed the current situation in the UK, its implications for pension funds and what might be ahead.
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