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Why September’s mini-budget threatened to bankrupt pension funds

21/10/2022

On Friday, September 23rd, now former Chancellor Kwasi Kwarteng revealed his mini Budget – the terms of which have now virtually all been reversed. It was a Budget that caused shockwaves across the UK economy: the value of the pound plummeted, the IMF publicly criticised the UK’s choices, and the Bank of England had to step in. 

Without the central bank’s intervention, there was a very real risk that swathes of pension funds could have collapsed. Here’s why. 

 

A collapse in gilt prices

Following the Budget announcement, UK Government bond (gilt) yields skyrocketed to levels not seen since just after the 2008 financial crisis. With gilts, rising yields tend to suggest that investors are unwilling to own this debt, sending gilt prices plummeting. 

 

The impact on liability-driven investment funds

One investment sector that felt the impact of rising gilt yields was liability-driven investment (LDI) funds. LDI is often sold to pension fund managers. By using derivatives, pension fund managers can balance out their assets and liabilities to avoid any shortfall when it comes to paying funds to those claiming their pensions.

In money-purchase pension schemes – such as SIPPs and personal pensions – this increase in gilt yields has, as a result, seen a fall in gilt fund values. This will have had a negative impact on pension funds that include LDIs. 

As a result of the increase in gilt yields, pension funds may have found that their assets were significantly lower than their liabilities to LDIs – which could have meant that many faced insolvency if nothing had been done. 

 

The Bank of England steps in

Shortly after the Budget announcement, the Bank of England confirmed that it had stepped in to purchase “targeted government bonds” to avoid the need for any pension schemes to be wound up. In light of what happened in late September, the Bank of England has also confirmed that it is working with both The Pensions Regulator and the FCA to improve the resilience of LDI funds going forward.

 

“Stable Rise Limited is not authorised or registered by the Financial Conduct Authority. The marketing materials are not intended to provide financial advice nor promote any individual financial products.”

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