UK pension funds ask corporates for cash after gilt blow-up -sources

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Pound banknotes are seen in this illustration taken March 1, 2022. REUTERS/Dado Ruvic/Illustration

LONDON, Sept 30 (Reuters) - British pension funds with big losses in gilt market derivatives have sought emergency funds from the companies they manage money for as they race to dump assets to raise cash, industry sources said on Friday.

Many pension funds were caught out during the surge in bond yields this week that forced the Bank of England to step in. The funds had to stump up cash to meet collateral demands.

Some funds crashed out of derivative positions because they could not raise the money in time, but are trying to put those hedges back on so they are not exposed to further volatile moves, the people said. The cash demands from liability-driven investment (LDI) funds that manage the derivatives prompted a crisis that threatened many of Britain's biggest pension funds. Some fear it could spread wider contagion.

Some pension funds sought help from their sponsors, the parent entities whose employees' pensions they manage, including trying to open credit lines with banks, according to three pension consultants and one pension fund manager.

The extent of the liquidity squeeze on pension funds remained unclear after the Bank of England on Wednesday said it would buy 65 billion pounds ($72.21 billion) of gilts and postponed plans to sell bonds it already holds. "Schemes are looking to do whatever they can to reinstate their hedges", including seeking standby facilities with their sponsors, said Simeon Willis, chief investment officer at XPS Pensions Group. One pension fund manager, who spoke on the condition of anonymity, said his scheme had requested its parent open up a credit line on Wednesday when it looked like it was running out of cash but was refused. The BoE then made its announcement, sending bond yields lower and easing the panic.

The pension scheme of Serco, the outsourcing giant, requested a credit line from its parent, British media reported on Friday. Serco declined to comment.

"We've had companies understand the importance of the hedge saying can we support the pension schemes, and we've had pension funds looking at their short-term liquidity facilities," said Calum Mackenzie, investment partner at Aon.

LDI strategies help pension funds match their liabilities, the future payouts they must make to pension members, and their assets.

The market has boomed in the past decade and in Britain totals almost 1.6 trillion pounds in assets, according to the Investment Association. read more

These strategies, sold by the likes of BlackRock, Insight Investment and Legal & General, are complex, use derivatives and leverage, and are designed to protect against volatile price swings in gilts.

But markets moved so fast this week that the strategies could not keep up.

The pension schemes were forced into selling assets to raise cash but found everyone was doing the same, pushing the price of those bonds even lower and prompting more calls for cash in a "doom loop" that by Wednesday the BoE had decided threatened financial stability.

Banks expect pension funds will try to stay as liquid as they can, and sell other assets.

"Funding surpluses will likely be used to reduce leverage, rather than hunting yield. Assets will be kept as liquid as possible," said Estian Schoonraad, who works on RBC Capital Markets' LDI team, in an email sent to pension funds on Friday and seen by Reuters.

"For the immediate market implications, I expect the selling of less liquid assets to continue more gradually as the market stress abates. Any recent forced selling of gilts + linkers could be replaced when conditions allow."

Pension funds own anything from government and corporate bonds to stocks and less liquid investments like those in private equity.

RBC did not respond to a request for comment. Insight and L&G declined to comment. BlackRock said it was cutting leverage in its LDI funds. read more

($1 = 0.9002 pounds)

Reporting by Carolyn Cohn and Tommy Reggiori Wilkes; Editing by David Gregorio

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