Are UK pensions safe?

Pension funds are facing a “cliff-edge” after the Bank of England (BoE) warned that its emergency intervention in the UK’s debt market will come to an end on Friday.

BoE governor Andrew Bailey had been urged to extend the central bank’s multi-billion-pound bond-buying programme, which has been propping up pension funds. But in a “blunt” statement on Tuesday evening, he told investors they had three days to prepare for the support to end, said the BBC.

Speaking to the BBC after his statement, Bailey said that pension funds had “an important task” to ensure they were resilient. “I’m afraid this has to be done for the sake of financial stability,” he added.

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The pound dropped sharply against the dollar following the announcement, hitting $1.09 for the first time since the Bank announced its emergency intervention on 28 September, as investor hopes for further intervention were “dashed”, said the broadcaster.

But the Financial Times (FT) suggested the BoE could be prepared to extend the emergency bond-buying scheme “if market conditions demanded it”. Pension funds have said that they need more time to “shore up their derivative strategies” before central bank support ends, to avoid a repeat of the sell-off that forced the Bank to intervene last month, said the paper.

What did the papers say?

“Final salary pension schemes running out of cash was not a crisis that many people had predicted,” said the Investors’ Chronicle. The crisis was sparked late last month when chancellor Kwasi Kwarteng announced a series of unfunded tax cuts in his so-called ‘mini-Budget’.

In the end it ended up as a somewhat larger fiscal event, with Kwarteng’s mini-Budget “sparking investor fears over the UK’s financial stability”, said the BBC. It resulted in a “major sell-off” in the bond market, leaving pension funds – which are major investors in government bonds – stuck in a “doom loop”, where they were forced to sell off more government bonds, reportedly leaving some pension funds close to collapse, according to Politico.

It was only when the BoE stepped in and pledged to buy up to £65 billion of government bonds, known as gilts, until 14 October that the “doom loop” stopped and pension funds “gained time to meet cash calls and stop the contagion from spreading”.

The problem originated from what are called liability-driven strategies (LDI), “a term that refers to investment strategies now commonly used by pensions to manage their liability risks” and which “typically include hedging against interest rate and inflation risks” by using government bonds as leverage, explained Investors’ Chronicle.

When the value of bonds fell, investment banks called on these LDI funds to put up assets or cash as securities for loans. Pension funds also began selling their liquid assets, including government bonds, forcing prices to drop even further. The BoE eventually stepped in to stabilise this “vicious circle”.

What’s next?

The BoE has indicated it is unwilling to become a “permanent backstop” for the City which “steps in whenever there is a bit of turmoil”, said The Guardian. This ultimately creates a “moral hazard” that encourages “risky behaviour”. Setting a time limit of the end of the week allows pension funds to “untangle their complex derivative positions, dust themselves down and get back to providing workers with their annual retirement incomes”.

But the BoE has “privately signalled to some bankers” – despite Bailey’s comments on Tuesday – that it could be willing to extend the emergency bond-buying programme past Friday’s deadline. The FT reported that “several bankers” had been briefed by the central bank that officials were closely watching whether LDI managers “have been able to build up enough cash reserves to enable their clients to meet margin calls” before deciding whether to extend support.

Ultimately, the drop in bond prices is likely to help pensions in the long run, said The Guardian. Once pension schemes have “succeeded in solving their liquidity issues”, it means the bonds they hold will “pay a higher rate of interest and over the longer term”.

But it is in the short term that pension funds could face difficulty, as schemes “face the choice of selling higher returning assets to keep their hedges in place, or jettisoning or reducing the protection of the hedging strategy”. If the latter were to happen, then it would “leave pensioners exposed to future swings in rates and inflation”, said the FT.