The gilt LDI crisis, 2022

Pension hedges that worked, and could not be funded

UK pension schemes hedge the interest rate and inflation sensitivity of their liabilities using gilts, gilt repo and swaps, often with leverage so that a small pool of collateral supports a much larger hedge. When gilt yields rose sharply after the September 2022 fiscal statement, those hedges lost value and generated collateral calls; meeting them meant selling gilts, which pushed yields higher still. The Bank of England intervened to stop the loop. Nothing about the hedges was wrong — the schemes were better funded at the end than at the start.

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What the lesson covers

1. What happened
2. The position
3. Why it broke
4. What it cost
5. What it teaches

Key terms

• Liability-driven investment — Investing to match the interest rate and inflation sensitivity of a scheme’s liabilities rather than to beat an index.
• Gilt repo — Borrowing cash against gilts, the usual way an LDI fund obtains leveraged exposure.
• Collateral buffer — The headroom a leveraged hedge holds so that a yield move produces a call it can meet without selling.
• Funding level — A scheme’s assets against its liabilities — which improved through the crisis, even as its liquidity failed.
• Doom loop — A self-reinforcing spiral where meeting a call requires selling the asset whose fall caused the call.
• Financial stability operation — A central bank intervention aimed at restoring orderly markets rather than at setting monetary policy.

In practice

LDI is still how UK schemes hedge, and it is meant to be — the alternative is an unhedged liability. What changed is the buffer, the governance around topping it up, and the operational speed of moving collateral, which for several schemes in 2022 was slower than the market moved.

Read next

• Interest Rate Swap — Trade fixed for floating payments
• Collateral and the CSA — The cash and bonds that back an OTC exposure
• The LME nickel squeeze, 2022 — A hedge that could not be delivered into

In the app, The gilt LDI crisis, 2022 carries a five-step lesson, a worked example and a bank of twelve questions drawn differently every sitting.

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