Economy

Explainer – Why are Britain’s pension systems dumping government bonds?

Explainer – Why are Britain’s pension systems dumping government bonds?

LONDON (Reuters) – A surge in UK government bond yields this week has sparked calls for liquidity from defined-benefit pension funds, forcing them to cut positions and prompting the Bank of England to implement a 65 billion pound ($69 billion) emergency bond-buying programme. ). Trying to stabilize the market.

What are defined pension schemes?

Defined Benefit (DB) pension systems pay retirees a fixed annual amount, often a percentage of the final salary they earned as employees.

Most of these schemes are closed to new members due to their cost. But there are about 2 trillion pounds ($2.15 trillion) in the assets of Britain’s DB pension system.

Pension systems typically invest more than half of their assets in bonds, in order to pay off pension obligations decades into the future.

How is hedging done?

To avoid exposure to market volatility, schemes typically hedge their positions through gilt derivatives managed by so-called liability-driven investment funds (LDIs).

For example, pension plans may pay the floating rate portion of an interest rate swap and receive fixed rates, according to Chris Arkari, head of capital markets at Hymans Robertson Consultants.

Funds are raised which increases their exposure to market movements.

Why were they required to have cooperative societies?

If the returns go up too high and too fast, the schemes need to provide more cash – or collateral – to the LDIs because their positions become money-losing – they are paying out more money in the transaction than they receive.

Patrick O’Sullivan, head of investment advisory at Redington, said he advised schemes to hold cash reserves to counter a 200 basis point rise in swap rates over the course of a year. However, the 30-year gilded interest rate swaps [GBPSB6L30Y=]For example, it rose 360 โ€‹โ€‹basis points this year and 120 basis points in the past few days, before the Bank of England intervened.

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Retirement programs have already faced calls for guarantees this year, but the moves this week have prompted emergency calls — so they may have only two days to pay.

Why did they sell gold?

There are two reasons, pension consultants say.

Pension plans either sold gold bonds to get cash ready to meet those side calls, or kicked out their derivative positions because they couldn’t pay in time and had to sell gold bonds to avoid being exposed to more sharp moves. LDI funds also sold index-linked securities to support liquidity in their funds.

What will the Bank of England do?

calm down the situation. โ€œThis should give the schemes time to process transactions in an orderly manner to get their status in order, so it is very welcome,โ€ said Dan Mikulskis, investment partner at LCP Consulting.

The pension regulator said he welcomed the move.

Advisers said LDI funds have put pressure on the Bank of England to act. “There are schemes that are running out of liquidity,” one of them said.

Who manages LDI funds?

Major fund managers such as BlackRock (NYSE:), Legal & General, Columbia Threadneedle, Insight Investment and Schroders (color :). Columbia Threadneedle confirmed it had spoken to the Bank of England about the issue. Other managers have not commented.

Will my pension deteriorate?

Pension funds have short-term trouble managing their exposure to gold, but higher rates reduce the amount of money they need to keep now to pay pensions in the future. So that should make their funding position stronger than before, making it easier for them to pay their pensions in the future. Sources say there is no problem with its solvency or about the payment of current pensions.

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(dollar = 0.9304 pounds)

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