Shortage of liquidity creates difficult situations for pension managers
News, Staff memo In September 2022, long-term UK interest rates rose sharply as the result of an unfunded budget proposal from the country’s government. This led to a liquidity crisis in many UK pension funds due to their management strategy. In a new Staff Memo, the author Mathias Andersson analyses why the problems arose in the UK, what implications this has for financial stability and what the corresponding risks and vulnerabilities look like in Sweden.
GBP 1,600 billion, or over two-thirds of the UK’s gross domestic product – that is the value of the guaranteed pension liability managed by UK pension funds via LDI (liability-driven investment) – a management strategy that recently contributed to the recent shake-up of the UK government bond market. Pension funds use the strategy to create leverage on their interest-bearing assets in order to better match the value of assets and liabilities. The leverage creates liquidity risks as the funds become the subject of collateral exchange depending on how interest rates develop. When interest rates soared in September 2022, the funds encountered liquidity problems and the situation became so serious that the Bank of England chose to intervene in the market to stabilise it.
From a financial stability perspective, a lack of liquidity can create difficult situations for pension managers that risk spilling over to other markets and agents. However, Swedish pension companies with financial guarantees to their pensioners do not use leverage to protect themselves against interest rates to the same extent as their UK counterparts. But they nevertheless have a significant presence in several markets whose functionality could be damaged if the companies were suddenly forced to sell large parts of their holdings. It is therefore important to remain vigilant about liquidity risks that may arise for financial intermediaries such as pension companies and the links they have with other agents in the financial markets.
By Mathias Andersson at the Financial Stability Department.
A Staff Memo provides members of the Riksbank’s staff with the opportunity to publish advanced analyses of relevant issues. It is a publication for civil servants that is free of policy conclusions and individual standpoints on current policy issues. Publication is approved by the appropriate Head of Department. The opinions expressed in staff memos are those of the authors and are not to be seen as the Riksbank’s standpoint.