The Bank of England has recommended the UK take swift regulatory action to strengthen the pensions market after recent bond market turmoil exposed shortcomings in its oversight.
(Bloomberg) — The Bank of England has recommended the UK take swift regulatory action to strengthen the pensions market after recent bond market turmoil exposed shortcomings in its oversight.
The central bank’s Financial Policy Committee said Tuesday the pensions regulator and Financial Conduct Authority should work with overseas regulators to ensure liability-driven investment funds are more resilient to higher interest rates.
“There is a clear need for urgent and robust measures to fill regulatory and supervisory gaps to reduce risks to UK financial stability,” the BOE said Tuesday in its Financial Stability Report.
Further action on LDIs will be needed after this interim intervention as part of a broader review into market-based finance including a first ever system-wide stress test of shadow banks globally, it said.
The report assesses the ability of the financial sector to withstand economic shocks. It painted a grim picture of the UK’s economic prospects while concluding the banking sector is well-placed to withstand even worse conditions.
“Economic conditions have deteriorated and inflation has increased substantially since Russia’s illegal invasion of Ukraine,” Governor Andrew Bailey said in an accompanying letter to the Treasury. The economic turmoil “is likely to continue to weigh on households, businesses and governments globally.”
Pension funds were caught on the hop by a rapid drop in gilt prices after the government’s September mini-budget, forcing them into a wave of asset disposals. The BOE stepped in to contain what it saw as “fire sale dynamics” with emergency measures to calm the market.
That has prompted questions about why a huge but hitherto sleepy corner of the financial sector could seesaw in this way and whether further risks may emerge. The BOE said it is looking at money-market funds and other shadow banking entities.
The central bank said many LDI pension funds and pension schemes lacked resilience to shocks and said there were shortcomings in banks’ understanding of funds’ ability to meet margin calls in stressed scenarios. The BOE estimates that LDI funds faced more than £70 billion of collateral and margin calls over the crisis period.
It also warned that the UK faced an “acute risk to UK financial stability” from a collapse in foreign investor demand for government debt due to the country’s reliance on what former BOE governor Mark Carney called the “kindness of strangers.”
The report also said that the UK housing market — while resilient — will be under strain. Monthly payments for an average household with a fixed-rate mortgage expiring by the end of next year are expected to increase by a third to £1,000.
Still, even if economic conditions worsen the capital and liquidity positions of UK banks means they should be well placed to absorb unexpected shocks, the report said.
Other highlights:
- Highly leveraged corporate borrowing, particularly in the US, is another vulnerability with the stock of outstanding leveraged lending in the US now $3.5 trillion at the end of September
- The sudden failure of FTX highlights the need for enhanced regulatory and law enforcement frameworks to manage risks in cryptoasset markets
- The central bank maintained the countercyclical capital buffer at 2%
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