Con Keating, CISI Bond and Fixed Income Forum Committee member, provides his view on the current crisis in UK bonds markets
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Anatomy of a Bond Crisis
A major part of the crisis in the UK bond markets over the last week in September 2022 was driven by calls on defined benefit (DB) pension schemes for additional cash collateral. These arose because these schemes have effectively borrowed in a secured manner. While the scale of the margin calls accelerated hugely over that dramatic week, resulting in the Bank of England having to intervene in the gilts market at the same scale as it had done during the global financial crisis, schemes have been meeting margin calls since June this year (see Chris Flood’s article in the Financial Times on 1 July 2022).
Schemes have used repo extensively, and repo is in essence secured borrowing. DB schemes have also used derivatives to ‘leverage’ their portfolios. This again is substantially secured borrowing. Iain Clacher, Professor of Pensions and Finance at the University of Leeds and Con Keating, another leading expert in this field, make a clear point on this: “A scheme could have had its entire portfolio invested in gilts and though the prices of those gilts have declined, it would have suffered no calls for cash and had no requirement to liquidate anything. Calls on repo arise principally because the repurchase price of the securities under repo is fixed and the market prices of those securities have fallen below that price. The counterparty therefore calls for additional cash collateral to limit their risk exposure as the other side of the repo contracts.”
There was significant and lasting harm done to the retirement prospects of millions of DC savers in the last week of September The current accounting standards and regulatory approaches lead to absurdities, they say. The most evident of these is considering schemes whose assets have declined in value by significant amounts, with the real risk of further falls in value, when the ultimate liabilities to scheme members are unchanged or higher, to be seen as financially stronger simply because the discount rate has risen, and the present value estimate of liabilities fallen.
“As well as this, there is genuine economic loss in what we are seeing,” they say. “This spills over from the world of defined benefit into the world of defined contribution (DC), and there was significant and lasting harm done to the retirement prospects of millions of DC savers [in the last week of September]."
There are many other questions which may be asked and to answer those the basic anatomy of the problem needs to be understood – the cause and not just the symptoms. “One thing is clear,” says Keating. “The Bank of England intervention has been a bail-out of those who borrowed, unwisely. The costs will ultimately be borne by the population at large. The Bank of England intervention is welcome but this is a problem deferred, not resolved.
Hear Con Keating discussing these issues live on CISI TV with Neil Brown, Chartered FCSI, chair of our Bond and Fixed Interest Forum, at 10.00 BST on Thursday 6 October.