The scale of asset sales by UK pension funds to meet collateral calls during recent turmoil in the sovereign debt market that prompted borrowing costs to soar could be as high as £500bn.
Academics on Wednesday provided the estimate to a parliamentary committee that was probing a crisis in the gilt market, which led to an emergency £65bn intervention pledge by the Bank of England.
The central bank stepped in to prop up bonds after thousands of corporate pension schemes tried to raise cash to meet collateral calls on derivative contracts put in place to mitigate interest rate risks to the scheme’s funding.
The action came after gilt yields soared, indicating that prices fell, at an unprecedented scale and pace following the Truss government’s unfunded tax-cutting “mini” Budget on September 23. Most of the measures in the fiscal plan have since been ditched.
Iain Clacher, a professor at Leeds Business School, estimated the scale of asset sales to meet the collateral calls by liability-driven investment managers at up to £500bn in his evidence to the work and pensions select committee.
“If you look at just the asset side, based upon the calculations that myself and (Con Keating) have done, we estimated that roughly £500bn is probably missing somewhere,” Clacher said.
“And this isn’t a paper loss,” he added. “This is a real loss because pension funds were selling assets to meet the collateral goals. When you sell those assets, you get cash; that cash then goes to the person that you’ve got to pay to.”
Keating, head of research at Brighton Rock Group, said the LDI market crisis was “entirely predictable” and could have been avoided had regulators conducted “adequate” stress tests on pension scheme use of leverage in LDI strategies.
“The big problem,” he said, was that “it was leverage which led to collateral calls when gilt prices came down, and short rates started to rise. And that’s what triggered everything else. And that was all entirely predictable, including its speed.”
He added however that “what we did not predict [was] an economically illiterate budget trigger”.