The £39bn Pension Protection Fund was forced to provide £1.6bn in cash as additional security for derivative-linked investment strategies during last week’s market turmoil that followed the UK government’s “mini” Budget.
The PPF, the lifeboat for the defined benefit pensions schemes of failing companies, is a long-standing user of so-called liability driven investment (LDI) strategies which threatened to unravel during a liquidity crunch this month.
Thousands of pension schemes using LDI strategies have scrambled to raise cash to provide additional collateral to prop up derivatives as gilt prices sank following Kwasi Kwarteng’s tax cut announcement.
The PPF has an in-house team which runs its LDI programme, which is designed to protect pension promises to almost 300,000 members worth an estimated £27.4bn from adverse movements in inflation and interest rates.
One of the biggest players in the LDI market, the PPF received collateral calls — demands for additional cash — totalling £1.6bn from its derivative counterparties in the volatile days running up to the Bank of England’s intervention to calm the gilt market on September 28, the PPF said. That took the total collateral calls it has received so far this year to around £2.5bn, according to the PPF.
“The PPF has plenty of liquidity with a substantial amount of assets in both cash and gilts and so we have been able to satisfy the collateral calls in good order,” said Barry Kenneth, the PPF’s chief investment officer. The PPF has since been repaid around £1bn in cash collateral as gilts yields have fallen.
Other schemes have yet to disclose the full extent of the collateral calls which covered about £1.5tn of the future commitments of the defined benefit pension sector and forced some to sell assets to raise cash.
None of the leveraged LDI pooled funds which are mainly used by smaller DB schemes were designed to withstand the violence of the move in long-term interest rates which occurred during the last week in September, said Kenneth.
Asset managers such as BlackRock, Legal & General Investment Management and Insight Investment are expected to require more cash to support LDI strategies in the future to reduce the risk of another liquidity crisis.
“LDI is not a broken concept but there will have to be changes to make sure the risks in the market are reduced,” said Kenneth.
The additional multimillion pound collateral bill for pension schemes will require them to sell more assets including equities, corporate bonds and possibly illiquid long-term investments such as property.
“No DB pension scheme was running short of assets but the speed required to satisfy the collateral calls put some at risk of a technical default [on their derivative contracts],” said Kenneth.
The PPF does not anticipate an increase in the bailouts for pension schemes with no new additions to its watchlist of potentially vulnerable schemes. While the increase in long-term interest rates brought short-term turmoil, it has also reduced the estimated value of future liabilities.
Just 17 new entrants with combined liabilities of £12.1mn joined the PPF in the financial year ending March 31, down from 39 new claims with a total value of £271mn in the previous financial year.
Strong investment returns in recent years have boosted the PPFs financial position with its funding ratio of assets to liabilities standing at 138 per cent at the end of March.
The improvement in the PPF’s financial position means that the annual levy it collects from DB schemes will drop to £200mn in the 2023-24 financial year, down from £390mn in 2022-23 and £630mn in 2020-21.
