Description
The nadir of Liz Truss’s short-lived premiership was the crisis in UK gilt markets that unfolded in late September 2022. Following the government’s mini-budget which pledged £45bn in unfunded tax cuts, international investors took flight, causing a run on sterling and an unprecedented spike in gilt yields. This triggered a liquidity crisis within UK defined-benefit pension schemes and the ‘pooled’ Liability-Driven Investment (LDI) funds in which they had invested. To stem the market panic fuelled by mounting collateral and margin calls, the Bank of England (BOE) was forced to launch a large but time-limited gilt buying programme. The episode has revived long-standing concerns about the use of LDI strategies by pension schemes to manage asset-liability positions whilst increasing leverage and returns to funds through the use of derivatives and repo markets. The paper aims to shed new light on the role and function of LDI funds in the UK, and to unpack the drivers and dynamics of increased concentration and ‘herding’ in UK gilt markets. We also set out to explain how and why industry and regulators collectively failed to foresee and/or mitigate the resulting accumulation of systemic risk in the face of repeated warnings.
