The Bank of England (BoE) has launched a liquidity scheme for larger qualifying pension funds. The scheme aims to enhance UK financial stability by providing support for pension funds and gilt prices should another liability driven investment (LDI) crisis arise or severe gilt market dysfunction be experienced again.
Few in the pensions sector will forget the crisis that ensued for many schemes adopting LDI strategies following the autumn 2022 mini-budget. A sharp rise in gilt yields created a liquidity crunch for affected funds, leading to a forced sale of gilts to raise cash, followed by the BoE intervention to restore stability.
The liquidity scheme launched by the BoE on 28 January, called the Contingent Non-Bank Financial Institution Repo Facility (CNRF), allows the bank to provide short term loans against gilts to various parties, including larger qualifying pension funds.
Some features of the liquidity scheme are:
It is open to Defined Benefit funds with gilt holdings in excess of £2 billion.
It is a contingent facility and funds wishing to participate need to apply in advance and complete the bank’s onboarding documentation, including the legal terms and conditions.
Should the bank determine that a distress event threatening UK financial stability has occurred in the future, it can, at its discretion, activate the scheme. Pension funds that have signed up in advance can then draw on the loan facilities available. The loans are secured by gilts provided to the bank as collateral by the participating pension fund.
During the 2022 LDI crisis, many pension funds addressed liquidity issues by receiving short-term loans from their sponsoring employers. The BoE facility, if activated in a future crisis, would provide a potential additional source of short-term liquidity support for larger qualifying pension funds.
The advances would be based on the value of the gilts provided by the pension fund as collateral (subject to a mark-down) and the interest rate paid under the scheme is expected to be attractive in times of stress, but relatively expensive compared to pricing in ‘normal’ times.
While the interest rate paid would be considered relatively more expensive than normal pricing, one aspect of the BoE Scheme is that the attractive pricing in times of stress is intended to support gilt values and avoid forced sell offs and the self-reinforcing ‘doom loop’ seen in the 2022 LDI crisis.
It is worth bearing in mind that the 2022 LDI crisis represented an extreme event for gilt markets and LDI strategies. Pension funds have learned from the experience and it remains to be seen what appetite there is from pension funds for a facility of this kind.
If you require assistance in these matters, contact Partner Edwin Mustard or Director Peter Alderdice, or your usual Shepherd and Wedderburn contact.