Bank of England encouraged to extend period of backstop support in bond markets

The Bank of England should consider extending the duration of its emergency intervention in U.K. bond markets, with fears in the investment industry that it may withdraw its support too early, money managers and pension fund representatives say.

The BOE stepped into bond markets in an effort to thwart risks to U.K. financial stability as gilt yields surged and prices plummeted triggered by a government announcement on Sept. 23 of unfunded tax cuts. In turn, some pension funds with liability-driven investment portfolios that used leverage for hedges received huge collateral calls. Pension funds sold out of their most liquid assets first — including gilts, and a vicious circle of falling prices, high demand and collateral calls emerged.

The bank pledged to buy up to £65 billion ($72.5 billion) in long-dated government bonds between Sept. 28 and Oct. 14 — about £5 billion per day. The move calmed markets, even though the bank did not purchase anywhere near the top end of its potential amount.

By Monday, the bank deemed it necessary to expand its purchases to up to £10 billion, and then on Tuesday, said it would buy up to £5 billion per day of index-linked gilts until Friday.

On Tuesday, BOE Gov. Andrew Bailey reiterated the deadline of Friday. Speaking at the Institute of International Finance annual membership meeting, he said: "My message to the funds involved and all the firms is you've got three days left now. You've got to get this done."

The comments triggered a drop in the pound sterling to below $1.10.

However, sources in the money management industry and representatives of pension funds warned that the BOE should consider extending the period of its intervention.

"Friday is a cliff edge for U.K. pension schemes," Arif Saad, London-based co-head of U.K. investment strategy at Van Lanschot Kempen, said in an email. "The current Bank of England deadline has not given schemes enough time to adjust to the new world of fast volatility and rising rates. U.K. pension funds still need to sell assets in order to provide the cash required for margin calls in an orderly fashion, but a lot of their portfolios are held in private assets — such as private equity and property — which don't have a liquidity profile that can be realized in a matter of weeks."

Had the bank spread its intervention over three months, for example, "it would have given pension funds more time to plan and stagger sales of private assets. As it is, a lot of the capital raised from those sales won't be available until the end of the year," Mr. Saad said. "The industry is waiting for the Bank of England to announce a thoughtful plan, with real intention, which gives the market a clear idea of how far they are willing to go. Ideally, this should extend support into the new year, and specifically address pension fund liquidity considerations so schemes, and their managers, can hedge their liabilities in a calm and controlled manner," he added. Van Lanschot Kempen has €99.6 billion ($97.6 billion) in assets under management.

Also calling for an extension to the backstop provision from the BOE are pension funds themselves. The Pensions and Lifetime Savings Association, which represents occupational U.K. pension funds and their members, said in a news release Tuesday that a key concern for pension funds is that the bond-buying period will end too soon. Many funds feel the program should be extended beyond Friday and at least to Oct. 31 — when the next "fiscal event" is set to happen with Chancellor of the Exchequer Kwasi Kwarteng set to unveil his next fiscal plan.

If purchases are ended, additional measures should be put in place to manage market volatility, the PLSA said.

The impact of the BOE's intervention on bond markets has already been short-lived, however. Following the intervention, 10-year U.K. gilt yields fell to 4.09% from 4.5% — but yields are now back up at 4.44%, Christian Kopf, head of fixed income at Union Investment Institutional in Frankfurt, said in an email. Union had €223 billion in institutional AUM as of June 30.

"The BOE still plans to end all bond purchases on 14th October, but it may well have to intervene for longer to stabilize markets," Mr. Kopf said.

However, Orla Garvey, senior fixed-income portfolio manager at Federated Hermes, said in an emailed comment that the BOE "will likely want to step away from the financial stability support as planned at the end of this week, but this is difficult to do without giving the market some comfort around what to expect regarding" quantitative tightening — when the bank will begin unwinding its more than £800 billion asset purchase facility — which had been scheduled to commence Oct. 31. Federated Hermes executives think this date will be pushed back to later in the year.

Federated Hermes has $632 billion in assets under management.

The initial intervention by the BOE was designed to give U.K. pension funds that were forced to rebuild their collateral pools and rethink asset allocations, sources said.

"I think pension funds will have spent this two weeks really building up a large pot of liquidity, looking at what assets they need to sell, what asset allocation they need to redo, and getting higher stress tests" on current yields, Craig Inches, head of rates in London at Royal London Asset Management, said in an Oct. 5 interview. He doesn't see the BOE as extending its bond-buying program beyond Friday.

Even if bond yields were to drift higher from this point, "I think schemes will be OK," he said, noting that the issue for the majority of pension funds was not the fact that yields moved higher and prices lower, but rather the speed at which they moved and demands for collateral were made. RLAM has £150 billion in assets under management.

Bloomberg contributed to this story.