British pension funds at the origin of a new financial crisis

On paper, nothing is more certain. UK pension funds manage the pensions of around 30 million Britons and are expected to look after their portfolios as prudently as possible. They are also closely supervised by financial regulators.

Yet it is from them that came the latest financial explosion. After the UK government’s budget was presented on September 23, a financial byproduct that pension funds were using on a large scale suddenly exposed their weaknesses, forcing them to urgently seek cash, often to no avail. The pound sterling fell to its lowest level against the dollar.

It took the intervention of the Bank of England (BoE), from September 28, to restore order. But it ended its support on Friday, October 14, amid general concern. ” One thinks that [cette aide de la banque centrale] will be insufficient”warned HSBC in a note, four days earlier.

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This misadventure, which has so far remained confined to the United Kingdom, could herald similar difficulties in the financial world. “The sequence of events has exposed the flaws in the new organization of the financial markets put in place after [la crise de] 2008”, said Daniel Tenengauzer, who heads market strategy at BNY Mellon, an American bank. For him it is a “first warning”.

To understand, you have to go back two decades. Throughout the Western world, inflation is under control and interest rates are falling structurally, which will go as far as the famous negative rate of – 0.5% of the European Central Bank. For pension funds, this is bad news. They normally invest in long-term treasury bills, which pay off regularly and reliably. But with interest rates at rock bottom, the yield is very bad.

Take out cash to cover losses

In order to compensate, pension funds, which provide a guaranteed level of retirement to their clients (known as defined benefits or DB) and serve around 10 million Britons, invented a new tool, called liability-driven investment (LDI), which adds to the “letter soup” of exotic financial products. These are structured to pay when interest rates fall. And as appetite comes with eating, a leverage effect is added: LDI funds borrow money to speculate on other financial products, in order to obtain a better return.

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