£23bn sold by LDI funds amid 2022 volatility; pooled funds 'forced sellers'

Liability-driven investment (LDI) funds sold around £23bn of gilts during the Bank of England’s (BofE) 2022 gilt market interventions, BofE governor, Andrew Bailey, has confirmed, highlighting pooled funds in particular as "forced sellers".

Speaking to the Treasury Committee, Bailey confirmed LDI funds sold "something like £23bn of gilts" during the period from the last week of September through to the middle of October, after the mini-Budget prompted market volatility.

"That doesn’t tell you the loss, of course; that is the gross sale," he clarified, explaining that BofE is unable to provide figures on what the cost of the "fire sale of assets” was to pension funds, partly due to the “distinctive form of accounting” used by pension schemes.

Looking back on the issues faced during the market volatility, Bailey highlighted the 15 per cent of LDI funds that are pooled funds in particular as "forced sellers", explaining that one key reason for this was that pooled funds have a limited liability structure.

"That is obviously essential in that structure because no one pension fund is going to take on the liabilities of every other pension fund that is in the pooled fund," he acknowledged, suggesting that the problem is that these funds had to therefore have triggers in them.

"If a single pension fund says, 'I’m not going to meet that collateral call; I’d rather walk away', given the shock, then the pooled fund has to handle it, given it has other funds in it," he explained.

"I think they do that by having triggers that say 'You have to start selling that piece of the assets' at that point, and so they became forced sellers. And that triggered a good part of the problem."

However, Bailey noted that the work undertaken around these issues with The Pensions Regulator (TPR) since 2018-19 focused on the 85 per cent of the LDI funds that are segregated, which may have left issues around the 15 per cent "relatively obscure".

"I think we must hold our hand up at this point and say that, by looking at the 85 per cent, the 15 per cent remained relatively obscure, and the fact that this legal structure was sort of buried in there was also somewhat obscure," he stated.

"The non-bank sector is a huge landscape, particularly globally, but we have a lot of parts of it in this country, so the challenge we have on our hands—obviously, we need the assistance from the micro-regulators—is how we get both the breadth and the depth of the coverage here. It is a pretty big challenge in that respect."

In addition to this, Bailey pointed out that while most of the segregated funds are UK domiciled, none of the pooled funds are UK domiciled, and instead are domiciled in parts of the EU.

“You have to further regulate,” he stated. “I mean, we are already doing that, by the way; I know the micro-regulators are, but you have another dimension to the regulatory situation.”

Looking back on the regulatory response already taken, BofE deputy governor for prudential regulation, Sam Woods suggested that "we are in a sort of stopgap situation", explaining that while the relevant regulators, including TPR, have outlined expectations for the level of resilience that needs to be maintained, "we need steady-state expectations as well".

"That is the next stage," he stated. "Although it is great that we have the stopgap, I think the real test here will be whether those steady-state regulations do the job."

Adding to this, Woods continued: "What will be interesting to see will be if you have those constraints in place and they limit the extent to which funds can leverage and—it is a bit unfair to put it this way—there is a bit of having your cake and eating it: you keep the returns from the higher returning assets you have and you leverage for the gilts part that you need for matching purposes.

"Once you have put in the requirement to be robust to that level of movement, is that still a commercially attractive thing for pension funds to do? That is what I think the debate will be about."

More broadly, Bailey confirmed that the BofE’s profits from the sales bought during the intervention are estimated at around £3.8bn, explaining that “the BofE does not get to keep that”, and this will instead be passed on to HM Treasury.

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