Cash Is King for Pension Funds After UK Funding Market Shocks

Greg Ritchie, Bloomberg News

A cash tray holding British pound banknotes and coins in a shop in Barking, UK, on Tuesday, Sept. 13, 2022. As the UK enters a period of public mourning after the death of Queen Elizabeth II, data releases are likely to show a temporary reprieve in inflation and a jump in wage growth. Photographer: Chris Ratcliffe/Bloomberg , Bloomberg

(Bloomberg) -- A dash for cash among sterling investors after market turmoil sparked by pension fund margin calls is coming at a bad time, according to an M&G Investments executive.

Nina Moylett, the firm’s head of cash and currency, sees her markets as divided between pension funds desperate for cash and others who have built up sufficient buffers. That’s become a crunch issue in UK funding markets and beyond this week after forced selling for collateral led the Bank of England to intervene to stem a rout in bond markets.

“The timing could not be worse with quarter end looming, increasing demand for bank balance sheet from non-bank market participants and an ever increasing war chest of cash from the liquidity ‘Haves’ chasing collateral,” Moylett wrote in a blog post on the firm’s website. “The urgent question -- with an unclear answer at the moment in my view -- is whether this could spill over into a broader liquidity breakdown.”

The BOE intervened as it was concerned collateral requirements on liability-driven investment strategies would have turned many pension funds into forced sellers of gilts. It warned that continued dysfunction could threaten financial stability and even damage the economy.

The Pension Problem That Threatened to Wreck the Gilt Market

So-called liability-driven investment strategies are popular among UK pension programs. They often employ derivatives with the aim of matching liabilities going out decades to the fund’s assets. The problem is the spike in gilt yields meant the counterparties to these deals are demanding more margin, meaning many funds need to raise cash by liquidating assets.

Pension funds are a significant provider of gilts to the repo market, where there is now some strain as bonds are either withdrawn from repo programs or lent out to raise cash to fund collateral calls, said Moylett, who also chairs the BOE’s Securities Lending Committee.

She stressed there are market participants that have ample liquidity in the form of cash right now. She has observed even more shoring up of cash buffers by these players over the past few days via shortening cash lending tenors, not extending term funding transactions and restricting liquid assets such as gilts from lending programs.

The risk, she says, is that the “have nots” look to restore their cash piles while the “haves” continue to shore up their ample liquidity.

“One thing that goes without saying is that cash really is king at the moment.”