Fright Among British Pension Funds as Bonds Buying Ends

It’s white-knuckle time for Britain’s pension plans. With U.K. government bonds, known as gilts, losing value, British retirement plans are in a hole as their fixed-income holdings have shrunk.

The nation’s central bank, the Bank of England, has been buying gilts to buoy the bonds’ prices. But to the dismay of the pension systems, the BofE seems set to quickly end the purchases Friday.

As a result, gilt prices have slipped anew and their yields have climbed to almost 4.2% —up almost a full percentage point from three weeks ago, when this whole mess started. This unwelcome development means that the schemes, as British pension plans are incongruously (to American ears) known, must unload more price-depressed bonds to raise cash required as collateral for their hedging positions, among other things.

Upshot: Fright in the City of London, the U.K.’s financial district. On the equity side, the FTSE 100 index has tumbled almost 9% since mid-September. The schemes are worried about being able to meet hefty margin calls on the hedging strategies involving derivatives—and ultimately damaging their ability to pay beneficiaries.

The Pension and Lifetime Savings Association, which represents the DB plans (with their £1.6 trillion in gilt face value, or almost US$1.8 trillion), urged that the BofE keep going with the bond buying. “The period of purchasing should not be ended too soon,” the PLSA declared in a statement. And if it is, “additional measures should be put in place to manage market volatility.” In other words, to push bond prices back up. A bond-buying continuation doesn’t appear likely, however.

The crisis was touched off when the new prime minister, Liz Truss, announced big tax cuts and spending increases in September to bolster Britain’s flagging economy. She did so without specifying how these efforts would be funded, although new gilt issuance seems like the only alternative. Amid an uproar in her own Conservative Party, Truss has since axed the tax decreases, but the rest of her proposal still stands. So, the gilt rout rolls on.

With little demand for gilts, the BofE stepped in and spent £8 billion to bolster the market. And now the bank’s chief, Andrew Bailey, seems bent on folding the effort this week.

British pensions have £1.5 trillion (US$1.65 trillion) in bond assets, and about half of U.K. corporate defined benefit assets are in bonds. As of the first quarter, pensions owned 28% of outstanding government debt. This arrangement worked fine as long as interest rates were low. Although liabilities grew during this period, the pension plans countered by magnifying their returns with debt-fueled derivatives.

Lately, though, rates have climbed—and bonds have plunged in value. The Federal Reserve is the leader in the global rate hikes, and many other central banks have followed it.

Will this bond problem be confined to Britain? Maybe not. Megan Greene, the global chief economist at the Kroll Institute, warned in a Financial Times essay: “U.K. pension funds have been among the first bodies to float to the surface. I am certain they will not be the last.”

U.S. corporate DB plans have about the same amount of their assets in bonds as their British counterparts. While they seem to be in good financial shape, with a high average funded ratio, there are areas of vulnerability. For instance, private equity is an increasing part of their portfolios, and collateralized loan obligations are important to PE firms’ funding.