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UK pension funds have been Got into big trouble exposure to interest rate derivatives. With these financial products, they tried to protect the value of their investments against rising interest rates, but interest rates are now rising so fast that the funds can no longer meet the required margin obligations. The Bank of England even had to intervene to support the pension funds, but was unable to remove the uncertainty in the bond market. As a result, there is still a dark cloud hanging over the financial markets. What's going on in the world of pensions?
For most readers, the messages came as a complete surprise. How can pension funds suddenly be on the verge of collapse? Isn't rising interest rates beneficial for the funding ratio? To peel back this problem, we have to go back to September 23, when the British government led by the new Prime Minister Liz Truss launched a large-scale Fiscal Support Program Announced. It led to great indignation, because with this support program she mainly accommodated the rich. The market also questioned the financial underpinnings of the programme. Where was the money supposed to come from?
The financial markets therefore had no confidence in the government's support programme and sold British government bonds. Interest rates skyrocketed and the British pound plunged unprecedentedly. The speed with which UK interest rates shot up caused major problems for pension funds. In recent years, they have increasingly used interest rate swaps to absorb the risk of rising interest rates.
When interest rates rise, the value of government bonds held by pension funds in their portfolios decreases, while the value of these interest rate swaps rises. A hedging strategy, in other words. But in the event of an extreme interest rate movement, parties that take over the interest rate risk will run into problems. The margin requirements are increasing, which means that pension funds will have to put in more collateral immediately. And these are usually government bonds, which lose value when interest rates rise.
What followed was a sell-off among pension funds. They suddenly had to sell investments such as shares and bonds at a loss in order to meet the higher margin requirements for their interest rate derivatives. It led to panic in the bond market, because suddenly a lot of debt was sold and there were not enough buyers. This is despite the fact that government bonds owe their risk-free status to the fact that they are usually so easy to sell.
As a result, interest rates shot up even further and pension funds threatened to to fall. To break a self-reinforcing sell-off in UK government bonds, the Bank of England decided to September 28 to buy government bonds again. The market seemed reassured, but that was short-lived. The Bank of England stressed that it would stop buying government bonds after October 14. A remarkable statement, given that a few days before this deadline, they had to cancel the buy-back program. furthermore Expanded to calm the market.
UK government bond yields skyrocket (Source: True Insights)
This unclear policy has not removed the uncertainty among pension funds. As a result, interest rates have risen again, above the level at which the central bank decided to intervene at the end of September. Andrew Bailey, governor of the British central bank, said this week that it is up to the market to address these problems. Can be solved yourself. He should have known better, because in recent years all market participants have adjusted to a world in which central banks stretch the safety net when necessary. If that safety net is not in place, accidents can happen.
As a result, pension funds in the United Kingdom are now Major losses in order to be able to meet the margin obligations. It is estimated that they will have to set aside a total of £320 billion to do so, a big chunk of their investment portfolio. Of course, that money has not been lost, but the loss has already been incurred because funds had to sell many investments at a loss.
Pension funds in the Netherlands also have exposure to interest rate derivatives. At the beginning of this week, the Dutch Central Bank (DNB) wrote in its Quarterly Financial Stability Report that pension funds in our country have already had to sell €88 billion in investments this year, of which €82 billion was needed for higher margin requirements on interest rate swaps. If interest rates on Dutch government bonds suddenly rise rapidly, these problems will also come to our country.
This contribution was made from Geotrendlines
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