Pensions giant L&G moved to reassure markets of its cash position today after it was caught up in the economic fallout of the government’s mini-budget last week.
In a statement this morning, the firm said that “extraordinary increases” in interest rates and had “caused challenges” for its pension fund clients and the counterparties of its liability driven investment (LDI) business.
Pension funds deploying LDI strategies were put under extreme strain last week as they were forced to stump up cash for collateral demands , forcing them to scramble to sell off bonds and equities on the cheap to meet the calls.
The Bank of England stepped in with a bond-buying programme to steady the price of gilts and calm the volatility, which L&G said had helped to “alleviate the pressure on our clients”.
L&G said it had not had any trouble in meeting its own collateral calls, however.
“Despite volatile markets, the Group’s annuity portfolio has not experienced any difficulty in meeting collateral calls and we have not been forced sellers of gilts or bonds,” L&G said.
“One of the strengths of the UK insurance regime is that we regularly monitor and stress our capital and liquidity requirements to a 1 in 200 stress level so that we can withstand shocks like we have seen in the past few days.”
L&G boss Sir Nigel Wilson said the balance sheet and liquidity position “remain strong” and its businesses is “highly cash generative”.
“We continue to work closely with our customers to support them through this period of increased market volatility,” he said.
Bosses said the solvency coverage ratio as of 30 September 2022 was between 235-240 per cent, up at least 23 percentage points from the level in its half year results.
The group also said liquidity remains strong with £2.3bn of available cash across the Treasury and the LGC Traded portfolio, in addition to the large amount of cash and gilts held by the annuity portfolio.
What caused the liquidity crunch?
Liability Driven Investing became the watchword in the City last week as pension funds were pushed to a the edge of a liquidity crisis in the fallout of Kwasi Kwarteng’s tax slashing mini-budget.
Fund deploying LDI strategies, which hold around $1.5tn in assets, were being asked to post hefty collateral calls as the price of UK government bonds tumbled and yields soared. To do that, funds were selling off their liquid assets like bonds and equities to post more cash, which drove the price even lower.
The Bank of England eventually stepped in to steady the gilt market with a plan to buy up to £65bn worth of government bonds.
But what was it about the LDI strategies that put them at the heart of the crisis? And what are they?
“LDI started around 20 years ago and it has always been essentially a risk management tool,” says LDI expert Dan Mikulskis at City pensions specialist Lane, Clark and Peacock.
“We went through a period of time where corporate management suddenly cared a lot about what was going on with pension funding as accounting changes meant they had shifted onto corporate balance sheets.”
When firms looked into the funding of their corporate pension schemes, what they found was the deficit was often very big and swinging around an awful lot compared to the rest of the balance sheet.
The reason for that, Mikulskis says, was because the schemes’ liabilities are calculated by bond yields, interest rates and inflation.
LDI strategies essentially allow funds to hedge against these liability swings by using debt to invest some of the pension schemes’ assets in bonds and some in growth assets, but gain exposure that allows them to offset movements in liabilities.
While the strategies held firm through the global financial crisis in 2008 and the pandemic, the trouble last week came as bond prices tumbled and yields soared.
Funds were forced to sell off assets to meet sudden cash calls from counterparties in the sudden rise, which sparked the fears of a liquidity crisis last week.