Hymans Robertson's David Walker
There will be continued pressures on markets as schemes continue to liquidate assets to meet collateral calls and de-leverage their liability-driven investment (LDI) solutions, Hymans Robertson says.
The consultant said this week's intervention from the Bank of England highlighted the material risk to financial stability posed by dysfunction in the gilt markets, and the threat to UK financial stability.
It added that, while higher yields are ultimately beneficial to pension schemes, those with interest rate hedging have been required to find cash to meet collateral calls at increasing short notice as large upwards moves in yields occurred in quick succession.
Hymans Robertson senior partner John Dickson said: "As we approach the end of one of, if not the most, volatile weeks UK bond markets have ever experienced, it doesn't feel like "unprecedented" quite does it justice."
He added: "It's hard to see how a UK private sector defined benefit pension scheme won't have been impacted by the magnitude, speed and volatility of change experienced in the UK gilt markets over the last seven days. Even those schemes close to achieving their long term objectives have not been immune to these market events, with the rapid drying up of liquidity putting hedging strategies under extreme pressure."
Hymans Robertson chief investment officer David Walker agreed: "For schemes with collateral waterfalls in place, sources of liquidity will have become increasingly depleted given the scale and speed of the upwards move in rates and yields year to date, which have only intensified in the past week.
"If schemes are unable to meet collateral calls, they face the prospect of being required to reduce leverage, and hedging levels, within their LDI solution. The potential for multiple pension schemes unwinding hedges concurrently within a short time frame, would result in selling more gilts into the market. This would exacerbate the existing technical headwinds, placing additional upwards pressure on yields, triggering further collateral calls, and reducing market liquidity."
Walker said he anticipated there would be continued pressure on bond, credit, and other liquid markets as schemes continued to liquidate assets to meet collateral calls and de-leverage their LDI solutions.
He explained: "The most common forms of collateral may continue to see acute technically-driven selling pressure in the coming days and weeks. The intervention from the Bank of England has improved liquidity and provided some welcome relief, but we would stress the need for trustees to use this time to continue to keep their foot to the floor with regards to ensuring collateral sufficiency whilst also balancing resulting investment risk and return needs."
Next steps
In a briefing note, Hymans Robertson head of capital markets Chris Arcari agreed that the most common forms of collateral - short duration investment-grade, asset-backed securities, absolute return bond funds and buy and maintain credit funds - could continue to see selling pressure in the coming weeks.
Arcari said that while the time-limited intervention by the BoE had improved liquidity and reduced yields - providing some relief with regards further urgent collateral calls - he said it may not support liquidity beyond this short window to mid-October.
He added that LDI managers may seek to adopt more prudent frameworks for leverage management going forward to account for a more volatile gilt market environment.
Arcari added: "As such, we believe clients should continue to assess collateral sufficiency and reposition portfolios to ensure they are in a strong collateral position, with sufficient liquidity to meet agreed minimum requirements by 13 October.
"We will continue to actively engage with clients over the coming days and weeks to re-assess minimum protection levels and access to liquidity, re-positioning portfolios where required, and ensuring robust processes are in place ahead of the withdrawal of emergency liquidity support."
