Report: UK central bank says pension funds nearly collapsed amid market meltdown

According to the Bank of England, the pension funds which are managing vast sums on behalf of retired people in the UK came close to a collapse after an “unprecedented” meltdown in UK government bond markets following the Chancellor of the Exchequer, Kwasi Kwarteng’s mini-budget.

The central bank explained how the drastic increase in interest rates on long-dated UK government bonds in the days following the mini-budget announcement had triggered a “self-reinforcing” spiral in debt markets, said the Guardian. This threatened the stability of the British financial system.

The Bank of England stepped in last week after the British pound collapsed and became the lowest ever in history against the dollar. On the other hand, the interest rates on rates on UK government bonds rose to the highest ever since the 2008 global financial crisis.

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In a letter to the Commons Treasury committee, the Bank’s deputy governor for financial stability, Jon Cunliffe while explaining the bank’s intervention suggested that the biggest market movements came after the chancellor’s announcement of the mini-budget.

ALSO WATCH:UK unveils mini budget; historic tax cuts and borrowing in UK's new economic agenda

Explaining its emergency intervention to subdue the financial market turmoil they said how more than one trillion pounds invested in pension funds came under severe strain and a large number of which might have gone bust.

Reportedly, if they did not intervene and promised to buy 65 billion pounds of government debt, the funds managing money on behalf of pensioners “would have been left with negative net asset value” across the country. Subsequently, they would also have not been able to meet cash demands.

“As a result, it was likely that these funds would have to begin the process of winding up the following morning,” said the bank. They also went on to elucidate how the meltdown would have sent ripples through Britain’s financial system. This would have caused, “excessive and sudden tightening of financing conditions for the real economy”.

The currency had been “broadly stable” when on September 22 the bank increased interest rates. The long-term interest rates on government bonds rose by about 20 basis points during that time. However, after Kwarteng’s speech about 45 billion pounds of unfunded tax cuts, the Bank’s market intelligence was able to identify concerns by the pension fund managers.

Ministers had tried to argue that the turmoil in the market was reflective of global factors, the bank undermined the suggestion and published a chart which highlights a sharp rise in 30-year borrowing costs after the mini-budget. To show that this rise was not replicated in the US or the EU.

Amid this market turmoil, the value of UK government bonds fell sharply as investors began to lose faith in the UK Prime Minister Liz Truss’ administration to run a sustainable tax and spending policy. According to the report, this resulted in pension funds invested in liability-driven investment (LDI) schemes facing rolling “margin calls” as the value of the bonds pledged as collateral collapsed.

ALSO READ:Proposed UK tax cuts caused ‘a little turbulence’, says finance minister Kwasi Kwarteng

During the ongoing “self-reinforcing downward spiral” the funds moved to sell other long-dated bonds to meet cash demands which increased pressure in the bond market. The bank indicated that they heard intelligence that funds were preparing to sell at least 50 billion pounds of long-dated government bonds in a short time, which was at least four times the usual 12 billion pound average market trading volumes in recent weeks, said the report.

Prior to the bank intervention, the yields on 30-year UK government bonds reportedly rose by 35 basis points on two separate days. The biggest daily rise seen since the data that has been dating back to the beginning of this century was 29 basis points.

However, on Thursday, a Treasury spokesperson did not budge from their previous stance and blamed the market turmoil on global issues, “While the UK has seen disruption, global financial markets have also seen significant volatility in recent weeks.”

They added, the economy is in a “competitive position” and attributed it to the lowest level of unemployment in the country for almost 50 years and the second lowest net debt to GDP ratio among the G7 countries.

“Our growth plan will unleash growth and make the UK more competitive. The government is committed to strong fiscal discipline and to debt falling as a percentage of GDP over the medium term,” said the spokesperson. Indicating that further details will be shared during the upcoming medium-term fiscal plan shortly.

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