ALEX BRUMMER: Pensions fail a stress test amid UK bond market turmoil

When it comes to financial markets, you learn of new risks every day. At the time of the financial crisis in 2007-8 the country had to get its head around sub-prime mortgages, collateral debt obligations and all manner of complex instruments loaded on to the balance sheets of our banks and building societies by the casino investment banks.

That’s why we should be grateful that consumer banks have been ring-fenced from their far-too-clever trading arms for almost a decade.

Now we learn of a new horror at the heart of the UK’s defined salary pensions system. If you thought your money was safely locked up in gilts, quoted shares and other tangible assets, that isn’t quite right.

Pension funds use ‘Liability Driven Investments to maximise returns by leveraging, or borrowing against, the assets in these funds

As a result of the current turmoil in the market for UK bonds, widely considered to be the safest asset that can be held because of His Majesty’s government guarantee, think again.

Rather than allowing assets simply to sit around doing nothing, the people who manage our pension funds, all £2.5trillion or so of them, are making them sweat. 

I have long wondered why it is worth the while of the big insurers and pension funds to lend shares (for a fee) to activists and hedge funds with agendas to make a quick turn, often at the ultimate expense of ordinary retail investors and the national interest.

It is the search for those elusive returns.

So it perhaps should come as no surprise that a giant new bubble ‘Liability Driven Investments’ (LDIs) has blown up at the heart of the financial system.

What is most scary is that it is hard-earned money, saved by working people over a lifetime, which potentially will be at stake.

Pension funds use LDIs to maximise returns by leveraging, or borrowing against, the assets in these funds.

If you thought that the precarious element in these funds are the shares, which have health warnings written all over them, then you were wrong.

The soft underbelly is the £1trillion tied up in Government bonds and borrowed against to the hilt.

So when bond prices tanked after Liz Truss’s government did its stuff to rescue growth, it set off a chain reaction. The collateral, the bonds, was no longer worth anything like the loans made against them.

The lending risked going bad, creating a potential catastrophe for both the pension funds and the banks.

Fears of a meltdown were in prospect and it was this which triggered a financial crisis-style intervention by the Bank of England after receiving an indemnity from the Chancellor. It does appear that the Bank of England’s Financial Stability Committee had its eyes on LDIs back in 2018.

But anyone who has ever read one of its reports will know that it was also monitoring other, more glamorous risks to consumers and markets, ranging from crypto currency to credit card debt.

Something as technical as LDIs would normally never have been given a second glance. Now they’ve blown up in everyone’s face, with a potential bill to the taxpayer.

Someone, somewhere – either the Bank of England or the Pensions Regulator – must take responsibility for an appalling debacle in an industry where the watchword must always be safety.

Fund funk

As someone who has followed the activities of the International Monetary Fund (IMF) for longer than I care to remember, one couldn’t be anything but disheartened by its knee-jerk response to economic measures ushered in by Liz Truss.

The Washington-based fund has a reputation for its economic integrity, and provides the yardstick against which other forecasters are judged.

Its annual ‘Article 4’ inspections of national economies are based on thorough studies of the books, and interviews with top elected and other officials over several weeks.

So it is beyond comprehension that this august body should think it necessary to rap the UK across the knuckles over Kwasi Kwarteng’s fiscal package.

It has not proved ideal that the package was unsheathed without a longer-term plan to restore Britain’s public finances to order. But that is no excuse for hostile IMF comments.

It should recall how Kristalina Georgieva, its managing director, allegedly favoured China in her previous job at the World Bank, arousing US hostility to her stewardship.

Beware of throwing stones.