Navigating the Impact on the Pension Buy-Out Market
Nearly a year on from when former British Prime Minister Liz Truss’ tenure was cut short after her mini-budget led to a near financial meltdown for the pension buy-out market, it is now public knowledge that the then chancellor, Kwasi Kwarteng, went ahead with the mandate – including the biggest package of tax cuts in generations – despite warnings from the Office for Budget Responsibility that the largely unfunded growth plan would put immense strain on government borrowing. Writing in the Sunday Telegraph Newspaper, Truss wrote that she was unsuccessful due to economic ‘orthodoxy’ and a ‘blob of vested interests’. So what were these interests that meant markets reacted the way they did?
Margin Call – The Turmoil Impacting the Pension Buy-Out Market
Earlier this year, The Bank of England (BoE) finished unwinding its emergency bond-buying scheme that it had launched to calm financial markets. Government bonds, relatively stable debt securities, constitute around half of the £1.5 trillion worth of assets pension funds hold. After the mini-budget caused the pound to tank to almost parity with the dollar, investors lost confidence in the government, and this triggered a fire-sale of bonds – made worse by the margin-called pension funds who were also dumping gilts to reach collateral requirements. They were inches away from insolvency, saved only by the BoE’s Quantitative Easing (QE) style scheme. Economists will know that the plunging price reflects inversely-related soaring yields which, for 30-year long dated bonds, increased by more than a percentage point. Since the crisis, the BoE has stress tested the financial industry to be able to withstand yield increases twice as high as the debacle last year. With the likes of Silicon Valley Bank and Credit Suisse both falling victim to macroeconomic uncertainty, the pensions industry remains firmly in the crosshairs of regulators. But what should happen now?
Hedging Your Bets – Pension Strategies in Times of Uncertainty
Experts are still debating what went wrong. The answer lies somewhere in the chasm of pension funds’ most important strategy: Liability-Driven Investment (LDI). Jon Ralfe, an independent pensions consultant, explains the ‘world of difference’ between regular LDI and Leveraged LDI (LLDI). It is the latter, he says, that caused the issues. LDI intends to ensure pension funds can meet future liabilities by matching assets that reduce the risk of inflation and interest rate volatility. This is known as hedging. However, in the aftermath of the gilt market turmoil, LDI managers such as BlackRock and Legal and General (LGIM) find themselves locked in a blame game with investment consultants and regulators over allegations pointing to leveraged investments, essentially speculation, increasing risk for the entire industry. This raises questions as to why pension consultants aren’t being held to higher standards and supervision by the Pensions Regulator. The parties involved may have their differences, but they will agree on one thing, and that’s the need for far more disclosure of strategies such as LLDI and, more importantly, liquidity buffers (so history doesn’t repeat itself).
Outlook
Defined Benefit (DB) pension schemes have been a long-standing pillar of retirement planning, offering retirees a secure and predetermined income during their retirement years. However, these schemes have faced significant challenges over the past few decades, leading to increased financial pressures on pension funds and sponsoring employers. The importance of the pension buyout market as a viable solution to address these challenges cannot be underestimated. The market plays a crucial role in our economy and will now be put to theultimate test. An intensely regulated environment, the BoE proceeding with Quantitative Tightening (QT), and an ageing population paint a landscape where industrial action also remains largely unaddressed. Will pension funds live to fight another day? For your sake, you better hope they do.
Written by Alok Jadva
Produced by Madhav Bhimjiyani
Great summary!