It may take FIVE YEARS to unravel crisis in pension funds

It may take as long as five years to unwind toxic derivatives built up by pension funds that nearly crashed the government bond market, experts have warned. 

The Bank of England is locked in talks with asset managers to avert another crisis when its support package worth up to £65billion ends on Friday. 

It was forced to intervene last month to avert a potential £50billion sale of government IOUs – known as gilts – that could have triggered a collapse in UK asset prices, including company shares. 

One step at a time: Regulators who failed to spot the crisis are under pressure to curb the use of liability-driven investments

The sudden and unprecedented drop in the value of gilts after Chancellor Kwasi Kwarteng’s mini-Budget forced pension fund managers to find more cash.

That meant they had to sell gilts, causing their value to plunge further. 

The Bank said it feared that a ‘self-reinforcing spiral’ may have wiped out the value of liability-driven investments (LDIs) designed to protect the pension funds of 10million workers from higher interest rates and inflation. 

Its intervention has calmed markets, although gilt yields – which move in the opposite direction to prices – have stayed stubbornly high at above 4 per cent. 

Regulators who failed to spot the crisis are under pressure to curb the use of LDIs. ‘If pension funds were told they had to unwind their LDIs, this would take years to implement,’ said Mike Eakins, chief investment officer at insurance group Phoenix. ‘Decisions about their future shouldn’t be rushed.’ 

However, the need to restore stability to the gilts market is immediate. Chris Sier, chief executive of the Clear Glass pensions consultancy, said: ‘There are no good outcomes, just least worst ones. Someone will be left carrying the can.’ 

He added that the biggest buyers of gilts are UK final salary pension schemes. ‘But if they are forced to sell gilts to unwind their LDI positions, who is going to buy government bonds? 

‘If the Government can’t sell its debt, how is it going to fund its borrowing? The fate of its tax-cutting plans is in the hands of bond investors,’ Sier said. 

Sier’s firm has surveyed more than 600 defined-benefit private plans and discovered more than two-thirds of them used LDIs. 

LDIs are used in final salary schemes to ensure they have enough money for future retirement payouts. 

They have grown in popularity in recent years to account for more than £1trillion of pension fund investments. They were sold to fund trustees as an apparently safe way to match a fund’s assets with its liabilities, though this turned out to be a false assumption when gilt yields shot up. 

City analysts are divided about what the Bank of England will do next. Some reckon it will continue to act as a buyer of last resort for gilts until Kwarteng unveils a fully costed Budget next month. 

Others argue that extending the Bank’s backstop will only distort the bond market further and delay a reckoning. 

The Bank of England said regulators were ‘closely monitoring the progress of LDI funds as they take action to put their positions on a sustainable footing for whatever level of asset prices prevail at the end of (our) operation and to ensure LDI funds are better prepared for future stresses given the current volatility in the market’. 

Legal & General, BlackRock and Insight Investment are the biggest players. The trio account for 90 per cent of the LDI market.

This post first appeared on Dailymail.co.uk