The recent volatility in the gilt market showed the framework for managing liability-driven investment risk recommended by the Financial Policy Committee is functioning as intended, Sarah Breeden, the executive director for financial stability strategy and risk and a member of the FPC at the Bank of England, said in a speech Friday.
Between end of March and late May, the benchmark 30-year index-linked gilt yield rose by 82 basis points. During that time, the largest five-day move stood at 27 basis points.
Following LDI crisis in September, the FPC recommended a resilience framework for LDI funds, built on baseline and systemic resilience, meaning they can absorb a yield increase of 250 basis point at the minimum and fund specific additional resilience.
The framework also requires pension funds to put in place operational processes enabling them to deliver collateral within five days and to support LDI funds in drawing down during stress.
At the height of the crisis in September, poorly managed leverage at some LDI funds contributed to a sudden repricing of assets following the U.K. government's growth plan, which created a price spiral in the long-end of the gilt market.
The BOE then intervened in the gilt market in order to protect financial stability.
"Of course, LDI funds are not expected to self-insure against all possible shocks. But we do need to ensure there is the right balance between private self-insurance and a public backstop," Ms. Breeden said.
"Central banks cannot be a substitute for the primary obligation of LDI funds to manage their own risk," she added.
"But in situations where tail risks to financial stability materialize, the bank remains ready to act," she said.
The FPC wants to ensure that in the future gilt markets can continue operating even while suddenly repricing.
Funds should hold enough assets to absorb shocks without having to sell assets, she said, adding that pension funds can continue to invest in LDI funds if they can meet margin and collateral calls.
