## Market stress centered on Liability-Driven Investment (LDI) funds following the UK "mini-budget" announcement in September 2022

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---

### Historical background and lead-up to the LDI crisis
- Structural shifts in UK pensions since the late 1990s led many defined benefit (DB) pension funds to close to new members and shift from equity to fixed income.
- Active members of private pension funds:
  - DB schemes: decreased from 3 million in 2006 to 0.9 million in 2019.
  - DC schemes: increased from 1 million in 2006 to 10.6 million in 2019.
- As of mid-2022, DB schemes held close to 90 percent of total private pension funds’ assets.
- Asset allocation shifts in DB funds between 2006 and 2022:
  - Equity share: about 61 percent in 2006 to about 20 percent in 2022.
  - Fixed-income share: 28 percent to 72 percent.
- Growth in LDI usage:
  - Liabilities hedged through LDI strategies: £400 billion in 2011 to £1.5 trillion in 2020 (about two-thirds of UK GDP).
- Market structure and concentration:
  - Top three LDI managers occupy roughly 70 percent of the LDI market.
  - Pooled LDI funds make up between 10-15% of the LDI market.
  - About 175 pooled LDI funds with about 1800 pension schemes participating.
- Operational mechanics and risks:
  - Leverage implemented via repo and swaps; collateral generally cash and gilts.
  - Leverage requires posting collateral and margin; collateral shortfalls lead to margin calls and possible gilt liquidations.
  - Pooled funds face operational challenges raising liquidity quickly; segregated accounts have better access to additional assets and cash.

### The LDI crisis unfolding after the "mini-budget" and market impact
- "Mini-budget" and immediate market moves:
  - "Mini-budget" announced £45 billion unfunded tax cuts.
  - By the following trading day, the pound fell to its lowest-ever level on record (1.03) against the dollar.
  - The 30-year gilt yield jumped 140 basis points over three days.
- Direct effects on LDI funds and pension schemes:
  - Sharp increase in gilt yields caused steep declines in LDI fund net asset values and triggered margin and collateral calls.
  - Typical pension-fund timelines for raising collateral (days or weeks) were insufficient; the move required significant cash before the next business day.
  - Forced selling of long-dated gilts by pooled LDI funds contributed to fire-sale dynamics and gilt market illiquidity.
  - Other asset liquidations included MMFs and open-ended fund investments; some real estate funds suspended redemptions.
- Market amplification channels:
  - Large sales of long-dated and inflation-linked gilts in an illiquid market pushed yields higher, increasing collateral requirements and propagating stress across equity, corporate bonds, commercial papers, and gilts.
  - Liquidity mismatches in internationally active NBFIs identified as the main source of risk in core sterling markets.

### Bank of England’s financial stability intervention: design, execution, and outcomes
- Rationale and immediate action:
  - On September 28, the BoE announced a temporary and targeted purchase of long-term gilts to restore market functioning.
  - The BoE stated it would buy up to £5 billion daily in 20-year or longer-term gilts over 13 business days ending October 14 (implying a maximum of £65 billion in total).
  - Daily turnover in the long-term gilt market was around £12 billion.
  - The 30-year gilt yield dropped more than 100 bps on the first day of the intervention.
- Coordination and governance:
  - Bank Executive, following FPC recommendation, decided to intervene; HM Treasury provided full indemnification.
  - PRA, TPR, and FCA closely monitored rebalancing progress.
  - Regulators in Ireland and Luxembourg were engaged where some LDI funds are domiciled.
  - MPC was informed the operation was targeted and temporary and would not shift underlying inflation dynamics or interfere with monetary policy operations.
- Operational design choices informed by market intelligence:
  - Market intelligence indicated high leverage and limited ability to sell into a thin market, making swift gilt purchases preferable to a repo facility.
  - Repo facility ruled out because LDI funds needed to deleverage, not re-leverage; repo would provide funding liquidity but not market stability.
  - Operation used backstop pricing to remove the liquidity premium without distorting market prices.
- Escalation and expansion:
  - On October 10 the BoE increased the daily maximum auction size to £10 billion.
  - On October 11 the BoE widened purchases to include index-linked gilts and split purchases equally between conventional long-term gilts and index-linked gilts.
  - BoE announced a Temporary Expanded Collateral Repo Facility (TECRF) for banks through November 10 with expanded collateral, adding corporate bonds with credit quality of Baa3/BBB- or above.
- Market dynamics around intervention end-date:
  - Market participants worried about the October 14 expiration “cliff edge”; Governor Bailey communicated the intervention would end as planned to avoid moral hazard.
  - Fiscal policy reversals during October 3–17 (including policy changes on October 14 and October 17) materially helped calm markets and supported a sustained rally.
- Outcomes and unwinding:
  - The intervention lasted for 13 days and bought a total of £19.3 billion in long-dated gilts:
    - £12.1 billion in conventional gilts.
    - £7.2 billion in index-linked gilts.
  - DB pension schemes and LDI funds sold an estimated £37 billion in gilts over this period.
  - Estimated total margin and collateral calls faced over this period were roughly £70 billion.
  - LDI funds and pension schemes also sold assets other than gilts and used existing cash buffers; market intelligence suggests LDI funds raised tens of billion pounds in capital from end-investors.
  - The BoE successfully unwound all its financial stability gilt purchases by January 12, 2023.

### Key takeaways and policy implications (summary from main section)
- Core lessons organized into four areas:
  - Address regulation and information gaps.
  - Enhance NBFIs' liquidity management and oversight of leverage.
  - Clarify when and how central banks should provide backstops to NBFIs, or act as the lender of last resort.
  - Strengthen overall surveillance of the NBFI sector.
- Systemic relevance and interconnectedness:
  - Relative weight of NBFIs in the UK financial system has risen, increasing interconnectedness that could amplify and spread financial stress.
  - NBFI lending expanded notably in:
    - CRE and SME sectors: 37 percent in total non-financial corporate lending.
    - Specific mortgage products: 11 percent in total mortgages.
    - Unsecured consumer credit: 52 percent.
  - Nearly half of funding of UK finance companies comes from banks, creating significant linkages between NBFIs and banks and with overseas banks and asset managers.
  - Some non-bank lending (e.g., buy-now-pay-later schemes and corporate loans) remains outside the regulatory perimeter and lacks granular data for in-depth risk analysis.
- Regulatory and supervisory focus:
  - LDI episode highlights leverage, liquidity mismatches, and concentrated positions as central vulnerabilities that can cause rapid market dysfunction.
  - Lessons from the episode and the 2022 UK FSAP should inform strengthened monitoring, data collection, liquidity and leverage oversight, and crisis preparedness and response for NBFIs domestically and in other jurisdictions.

### Visibility of some parts of the NBFI sector, data gaps, and supervisory responses (section 18)
- Visibility and data gaps:
  - UK regulators have limited visibility and regulatory oversight of pooled and single client funds; leverage and liquidity data are not readily available.
  - Regulatory responsibilities:
    - PRA regulates bank counterparties of LDI funds.
    - BoE does not directly regulate pension funds, LDI managers, or LDI funds.
    - Pension schemes regulated by The Pensions Regulator (TPR).
    - LDI managers regulated by the Financial Conduct Authority (FCA).
  - Geographic fragmentation: pension funds typically based in the UK; investment funds operating LDI strategies largely based in Ireland and Luxembourg, requiring reliance on other jurisdictions for information.
  - FCA noted limited data availability on use of LDI strategies, leverage, and collateral.
  - Recommendation: BoE should consider how to collect information that fully matches its broader financial stability mandate.
- Lessons from past NBFI crises and information shortfalls:
  - Common threads: information gaps around NBFI activities and exposures, and lack of systemic oversight.
  - BCBS noted bank risk-management deficiencies related to NBFIs after episodes such as Archegos; similar deficiencies were demonstrated in the LDI stress.
- Importance of comprehensive data collection:
  - FSAP recommendation: collect or systematize reporting of data for all Sterling holdings by all investors to:
    - Enhance analysis of concentration of NBFI investors in key sterling markets.
    - Identify holders of various gilt maturities with similar business models and behavior in stress.
    - Assess implications for liquidity in these markets.
    - Support proper NBFI supervision and design of appropriate backstop facilities.
  - International coordination required; UK authorities should lead and strengthen information sharing with relevant third-country authorities and monitor internationally active NBFIs.
  - Example: ESRB uses AIFMD reporting to analyze and monitor NBFI risks; all UK pooled LDI fund managers are domiciled in the EU and their information can be accessed through AIFMD data.
  - Recommendation: UK authorities should seek regular access to AIFMD data through a bilateral agreement with the EU and explore other sources for higher frequency data.
  - Note: FCA reportedly receiving information from LDI managers on a more frequent basis now.

### Liquidity management, leverage, stress testing, and central bank backstops (section 18 continued)
- Liquidity management, leverage, and interconnectedness:
  - Key channels amplifying vulnerabilities: liquidity shortages, leveraged positions, and high interconnectedness.
  - LDI stress demonstrated how margin calls, asset sales (gilts), and dealer intermediation can amplify and spread stress.
  - Comparable past events: Archegos and Nickel—leverage, liquidity shortage, and interconnectedness created systemic risks where dealers intermediated markets.
- Strengthening liquidity regulation and stress testing:
  - Strengthen NBFIs’ liquidity management to reduce disruption risk and need for central bank backstops.
  - Recent lessons:
    - Stress tests were too mild; mandated liquidity buffers for NBFIs should be reevaluated and strengthened if required.
    - In immediate aftermath of the crisis, funds secured an average yield buffer (“headroom”) of around 300–400 bps.
  - Ongoing work: address liquidity mismatches in investment funds; enhance money market and open-ended fund regulation in line with recent FSB proposals.
  - MMF policy proposals: reduce liquidity transformation (hold a higher share of liquid assets) or move cost of redeeming to redeeming investors (swing pricing).
  - Ensure open-ended funds use adequate liquidity management tools.
- Ex-ante liquidity facilities:
  - Repo window set up by BoE involving banks did not work during stress, indicating banks unlikely to provide liquidity to NBFIs in crisis due to stricter post-GFC regulations.
  - Recommendation: pre-negotiate ex-ante liquidity facilities for NBFIs with banks, e.g., contingency liquidity lines; precedent exists in Denmark.
- Regulatory safeguards and resilience standards:
  - TPR set a minimum liquidity requirement for pension funds investing in LDI strategies (steady-state resilience) to withstand a 250 bps move in long-dated gilt yields.
    - Note: this is substantially higher than the 140 bps increase in long-term yields seen in a few days during the LDI crisis.
  - FCA and TPR guidance: enhance resilience in LDI funds via realistic contingency planning, appropriately designed stress tests, and ensuring clients can deliver collateral within five days.
  - TPR guidance requires trustees to invest only in leveraged LDI arrangements where there is a buffer of at least 250 bps to withstand severe market stress together with an additional operational buffer.
- Central bank backstops and BoE intervention design:
  - BoE’s intervention benefited from timely market intelligence which tailored response to LDI stress; intelligence indicated high leverage and need for swift intervention, leading to targeted gilt purchases rather than a repo facility.
  - BoE implementation differed from typical asset purchases: it had announced quantitative tightening (stop reinvestments from March 2022 and plans for active gilt sales) and was raising interest rates; intervention paused planned start of active gilt sales.
  - Tension between price stability and financial stability:
    - Opening central bank liquidity support to NBFIs may complicate price stability if it involves asset purchases and could raise moral hazard concerns.
    - Purchasing sovereign bonds to improve market functionality while raising policy rates and conducting quantitative tightening creates implementation challenges.
    - Clear communication on temporary and targeted nature of interventions is critical.
  - Recommendation: strengthen backstops for core market functioning (e.g., gilts) while minimizing moral hazard.
    - For entities with collected data, appropriate supervision, and systemic interconnectedness, consider granting access to BoE liquidity backstop focused on maintaining core market functioning (gilts and gilt repos).
    - Inclusion of certain NBFIs in BoE’s operational framework could widen options to counteract future market-wide stresses.
    - Facility design should reflect NBFIs’ diverse nature and include safeguards to avoid moral hazard.

### System-wide surveillance, stress analysis, and continued monitoring
- FPC historical stress analysis underestimated possible market moves:
  - 2018 assessment concluded most non-banks had sufficient liquid assets to meet margin calls under a 100 bps interest rate shock and asserted “a 100 bps increase over a single day, or a single week has never been experienced in 10-year sterling swap rates looking back to 1990.”
  - Actual late-September move exceeded this and liquidity shortfalls increased exponentially.
  - FPC analysis saw a £1.4 billion shortfall with a 100 bps increase in interest rates faced by NBFIs with total assets around £1.8 trillion.
  - During recent turmoil: pension funds raised £40 billion in cash.
  - Total LDI investment was about £1.5 trillion.
  - FPC cautioned that pension funds did not pay sufficient attention to liquidity risks.
- System-wide exploratory scenario (SWES) and continued monitoring:
  - FPC plans a SWES exercise focused on NBFI risks—voluntary but intended to cover most systemic NBFIs and their links to banks, including those domiciled abroad and core markets.
  - SWES aims to identify and possibly quantify risks including hidden leverage and channels of systemic risk propagation; should help close some NBFI data gaps and inform stronger regulation and supervision.
  - Continued horizon scanning required: NBFI sector is diverse, evolving, and adapting; monitoring and assessment improvements are necessary to identify vulnerabilities and respond to stress.
- Conclusions and policy implications:
  - LDI episode reiterated recurring NBFI vulnerabilities: liquidity stress, leverage, and interconnectedness.
  - BoE intervention restored market functioning and provided time for LDI funds to build more resilient positions, but further lessons remain.
  - Episode triggered by a fiscal event producing historical gilt yield moves, exceeding standard stress test parameters—highlights importance of macroeconomic policy coordination and reverse stress testing to identify extreme events and develop contingency plans.
  - Market intelligence is critical when data are unavailable or not timely; SWES can contribute to real-time decision-making capabilities.
  - Cross-border nature of NBFI activities necessitates international coordination to address vulnerabilities and avoid regulatory arbitrage.
  - Clear and regular communication among regulators and to the public is essential, particularly to explain actions when perceived tensions arise between monetary policy and financial stability.

*Source: sipea2023049 - Market stress centered on Liability-Driven Investment (LDI) funds following the UK "mini-budget" announcement in September 2022*

### 1.       Market stress centered on Liability-Driven Investment (LDI) funds following the UK

### Market stress centered on Liability-Driven Investment (LDI) funds following the UK "mini-budget" announcement in September 2022

### Historical background and lead-up to the LDI crisis
- Regulatory and demographic changes since the late 1990s led many defined benefit (DB) pension funds in the UK to close to new members and shift investments from equity to fixed income.
- Active members of private pension funds:
  - DB schemes: decreased from 3 million in 2006 to 0.9 million in 2019.
  - DC schemes: increased from 1 million in 2006 to 10.6 million in 2019.
- As of mid-2022, DB schemes held close to 90 percent of total private pension funds’ assets.
- Asset allocation shifts in DB funds between 2006 and 2022:
  - Equity investment share declined from about 61 percent in 2006 to about 20 percent in 2022.
  - Fixed-income investment share increased from 28 percent to 72 percent.
- Growth of LDI usage:
  - From 2011 to 2020, UK pension fund liabilities hedged through LDI strategies grew from £400 billion to £1.5 trillion (about two-thirds of UK GDP).
- Market structure and concentration:
  - The top three LDI managers occupy roughly 70 percent of the LDI market.
  - Pooled LDI funds make up between 10-15% of the LDI market.
  - There are about 175 pooled LDI funds with about 1800 pension schemes participating.
- Operational mechanics and risks:
  - Leverage in LDI strategies is implemented via repo and swaps; collateral generally a combination of cash and gilts.
  - Leverage requires posting collateral and margin; if liquidity buffers run out, managers send margin calls and may liquidate underlying gilts.
  - Pooled funds, with many small DB pension fund investors, face operational challenges raising liquidity quickly; segregated accounts have better access to additional assets and cash.

### The LDI crisis unfolding after the "mini-budget" and market impact
- "Mini-budget" details and market reaction:
  - The "mini-budget" announced £45 billion unfunded tax cuts.
  - By the following trading day, the pound fell to its lowest-ever level on record (1.03) against the dollar.
  - The 30-year gilt yield jumped 140 basis points over three days.
- Immediate effects on LDI funds and pension schemes:
  - Sharp increase in gilt yields caused steep declines in LDI fund net asset values and triggered margin and collateral calls.
  - Pension funds generally have several days or weeks to raise collateral, but the post-"mini-budget" move required significant cash before the next business day.
  - Forced selling of long-dated gilts by pooled LDI funds contributed to fire-sale dynamics and further gilt market illiquidity.
  - Other asset liquidations included MMFs and open-ended fund investments; some real estate funds suspended redemptions.
- Market amplification channels:
  - Large quantities of long-dated and inflation-linked gilt sales in an increasingly illiquid market pushed yields higher, increasing collateral requirements and propagating stress across core sterling markets (equity, corporate bonds, commercial papers, gilts).
  - Liquidity mismatches in internationally active NBFIs were identified as the main source of risk in those core sterling markets.

### Bank of England’s financial stability intervention: design, execution, and outcomes
- Rationale and immediate action:
  - On September 28, the BoE announced a temporary and targeted purchase of long-term gilts to restore market functioning.
  - The BoE stated it would buy up to £5 billion daily in 20-year or longer-term gilts over 13 business days ending October 14 (implying a maximum of £65 billion in total).
  - Daily turnover in the long-term gilt market was around £12 billion.
  - The 30-year gilt yield dropped more than 100 bps on the first day of the intervention.
- Coordination and governance:
  - The Bank Executive, following recommendation from the Financial Policy Committee (FPC), decided to intervene; HM Treasury provided full indemnification.
  - The Prudential Regulation Authority (PRA), the Pensions Regulator (TPR), and the Financial Conduct Authority (FCA) closely monitored rebalancing progress.
  - Regulators in Ireland and Luxembourg were engaged where some LDI funds are domiciled.
  - The Monetary Policy Committee (MPC) was informed that the operation was targeted and temporary and would not shift underlying inflation dynamics or interfere with monetary policy operations.
- Operational design choices informed by market intelligence:
  - Market intelligence confirmed high leverage and limited ability to sell into a thin market, making swift gilt purchases preferable to a repo facility.
  - A repo facility was ruled out because LDI funds needed to deleverage, not re-leverage, and repo would provide funding liquidity but not market stability.
  - The operation used backstop pricing to remove the liquidity premium without distorting market prices.
- Escalation and expansion:
  - Given concerns about gilt-selling pressure, on October 10 the BoE increased the daily maximum auction size to £10 billion.
  - On October 11 the BoE widened gilt purchases to include index-linked gilts and split purchases equally between conventional long-term gilts and index-linked gilts.
  - The BoE announced a Temporary Expanded Collateral Repo Facility (TECRF) for banks through November 10 with expanded collateral, adding corporate bonds with credit quality of Baa3/BBB- or above.
- Market dynamics around intervention end-date:
  - Some market participants were anxious about the October 14 expiration “cliff edge”; Governor Bailey communicated the intervention would end as planned to avoid moral hazard.
  - Fiscal policy reversals during October 3–17 (including policy changes on October 14 and October 17) materially helped calm markets and supported a sustained rally.
- Outcomes and unwinding:
  - The intervention lasted for 13 days and bought a total of £19.3 billion in long-dated gilts:
    - £12.1 billion in conventional gilts.
    - £7.2 billion in index-linked gilts.
  - DB pension schemes and LDI funds sold an estimated £37 billion in gilts over this period.
  - Estimated total margin and collateral calls faced over this period were roughly £70 billion.
  - LDI funds and pension schemes also sold assets other than gilts and used existing cash buffers; market intelligence suggests LDI funds raised tens of billion pounds in capital from end-investors.
  - The BoE successfully unwound all its financial stability gilt purchases by January 12, 2023.

### Key takeaways and policy implications
- Core lessons focus on four areas:
  - The need to address regulation and information gaps.
  - Enhancing NBFIs' liquidity management and oversight of leverage.
  - Clarifying when and how central banks should provide backstops to NBFIs, or act as the lender of last resort.
  - Strengthening overall surveillance of the NBFI sector.
- Systemic relevance and interconnectedness:
  - The relative weight of NBFIs in the UK financial system has risen, increasing interconnectedness that could amplify and spread financial stress.
  - NBFI lending expanded notably in CRE and SME sectors (37 percent in total non-financial corporate lending), specific mortgage products (11 percent in total mortgages), and unsecured consumer credit (52 percent).
  - Nearly half of the funding of UK finance companies comes from banks, creating significant linkages between NBFIs and banks and with overseas banks and asset managers.
  - Some non-bank lending (e.g., buy-now-pay-later schemes and corporate loans) remains outside the regulatory perimeter and lacks granular data for in-depth risk analysis.
- Regulatory and supervisory focus:
  - The LDI episode highlights leverage, liquidity mismatches, and concentrated positions as central vulnerabilities that can lead to rapid market dysfunction.
  - Lessons from the episode and the 2022 UK FSAP should inform strengthened monitoring, data collection, liquidity and leverage oversight, and crisis preparedness and response for NBFIs domestically and in other jurisdictions.

*Source: sipea2023049 - Market stress centered on Liability-Driven Investment (LDI) funds following the UK "mini-budget" announcement in September 2022*

### 18.      Visibility of some parts of the NBFI sector has improved, but the LDI episode showed

### 18.      Visibility of some parts of the NBFI sector has improved, but the LDI episode showed

### Visibility and data gaps
- UK regulators have limited visibility and regulatory oversight of pooled and single client funds; leverage and liquidity data are not readily available.
- Regulatory responsibilities:
  - Prudential Regulation Authority (PRA) regulates bank counterparties of LDI funds.
  - Bank of England (BoE) does not directly regulate pension funds, LDI managers, or LDI funds.
  - Pension schemes are regulated by The Pensions Regulator (TPR).
  - LDI managers are regulated by the Financial Conduct Authority (FCA).
- Geographic fragmentation of LDI investment funds:
  - Pension funds typically based in the UK.
  - Investment funds operating LDI strategies largely based in Ireland and Luxembourg, requiring reliance on other jurisdictions for information.
- FCA noted limited data availability on use of LDI strategies, leverage, and collateral.
- Recommendation: BoE should consider how to collect information that fully matches its broader financial stability mandate.

### Lessons from past NBFI crises and information shortfalls
- Common threads in recent crises: information gaps around NBFI activities and exposures, and lack of systemic oversight.
- BCBS highlighted bank risk management deficiencies related to NBFIs after stress episodes such as Archegos: insufficient information collection on clients' positions and exposures and limited efforts to understand clients' investing strategies; similar deficiencies were demonstrated in the LDI stress.
- Non-NBFI lessons (not elaborated here) include need for coherent policy packages, heightened market sensitivity to policy missteps, and interactions between monetary policy and financial stability.

### Importance of comprehensive data collection
- FSAP recommendation: collect or systematize reporting of data for all Sterling holdings by all investors to:
  - Enhance analysis of concentration of NBFI investors in key sterling markets.
  - Identify holders of various gilt maturities with similar business models and behavior in stress.
  - Assess implications for liquidity in these markets.
  - Support proper NBFI supervision and design of appropriate backstop facilities.
- International coordination required for data collection; UK authorities should lead and strengthen information sharing with relevant third-country authorities and monitor internationally active NBFIs.
- Example: ESRB uses AIFMD reporting to analyze and monitor NBFI risks; all UK pooled LDI fund managers are domiciled in the EU and their information can be accessed through AIFMD data.
- Recommendation: UK authorities should seek regular access to AIFMD data through a bilateral agreement with the EU and explore other sources for higher frequency data.
- Note: FCA reportedly receiving information from LDI managers on a more frequent basis now.

### Liquidity management, leverage, and interconnectedness
- Key channels amplifying vulnerabilities: liquidity shortages, leveraged positions, and high interconnectedness.
- LDI stress demonstrated how margin calls, asset sales (gilts), and dealer intermediation can amplify and spread stress.
- Comparable past events: Archegos and Nickel events—leverage, liquidity shortage, and interconnectedness created systemic risks where dealers intermediated markets.

### Strengthening liquidity regulation and stress testing
- Strengthen NBFIs’ liquidity management to reduce disruption risk and need for central bank backstops.
- Recent lessons:
  - Stress tests were too mild; mandated liquidity buffers for NBFIs should be reevaluated and strengthened if required.
  - In immediate aftermath of the crisis, funds secured an average yield buffer (“headroom”) of around 300–400 bps.
- Ongoing work: address liquidity mismatches in investment funds; enhance money market and open-ended fund regulation in line with recent FSB proposals.
- MMF policy proposals: reduce liquidity transformation (hold a higher share of liquid assets) or move cost of redeeming to redeeming investors (swing pricing).
- Ensure open-ended funds use adequate liquidity management tools.

### Ex-ante liquidity facilities
- Repo window set up by BoE involving banks did not work during stress, indicating banks unlikely to provide liquidity to NBFIs in crisis due to stricter post-GFC regulations.
- Recommendation: pre-negotiate ex-ante liquidity facilities for NBFIs with banks, e.g., contingency liquidity lines; precedent exists in Denmark.

### Regulatory safeguards and resilience standards
- UK authorities recommended stronger safeguards and operational resilience for pension funds and LDI managers.
- TPR set a minimum liquidity requirement for pension funds investing in LDI strategies (steady-state resilience) to withstand a 250 bps move in long-dated gilt yields,
  - Note: this is substantially higher than the 140 bps increase in long-term yields seen in a few days during the LDI crisis.
- FCA and TPR guidance: enhance resilience in LDI funds via realistic contingency planning, appropriately designed stress tests, and ensuring clients can deliver collateral within five days.
- TPR guidance requires trustees to invest only in leveraged LDI arrangements where there is a buffer of at least 250 bps to withstand severed market stress together this an additional operational buffer.

### Central bank backstops and BoE intervention design
- BoE’s financial stability intervention benefitted from timely market intelligence which helped tailor response to LDI stress; market intelligence indicated high leverage and need for swift intervention, leading to targeted gilt purchases rather than a repo facility for LDI funds.
- BoE implementation differed from typical asset purchases (which usually accompany monetary easing): BoE had announced quantitative tightening (stop reinvestments from March 2022 and plans for active gilt sales) and was raising interest rates; intervention paused planned start of active gilt sales.
- Tension between price stability and financial stability:
  - Opening central bank liquidity support to NBFIs may complicate price stability if it involves asset purchases and could raise moral hazard concerns.
  - Purchasing sovereign bonds to improve market functionality while raising policy rates and conducting quantitative tightening creates implementation challenges.
  - Clear communication by the central bank on temporary and targeted nature of interventions is critical.
- Recommendation: strengthen backstops for core market functioning (e.g., gilts) while minimizing moral hazard.
  - For entities with collected data, appropriate supervision, and systemic interconnectedness, consider granting access to BoE liquidity backstop focused on maintaining core market functioning (gilts and gilt repos).
  - Inclusion of certain NBFIs in BoE’s operational framework could widen options to counteract future market-wide stresses.
  - Facility design should reflect NBFIs’ diverse nature and include safeguards to avoid moral hazard.

### Overall surveillance and stress analysis
- FPC’s historical stress analysis underestimated possible market moves: 2018 assessment concluded most non-banks had sufficient liquid assets to meet margin calls under a 100 bps interest rate shock and asserted “a 100 bps increase over a single day, or a single week has never been experienced in 10-year sterling swap rates looking back to 1990.”
- Actual late-September move exceeded this and liquidity shortfalls increased exponentially.
- FPC analysis saw a £1.4 billion shortfall with a 100 bps increase in interest rates faced by NBFIs with total assets around £1.8 trillion.
- During recent turmoil:
  - Pension funds raised £40 billion in cash.
  - Total LDI investment was about £1.5 trillion.
- FPC cautioned that pension funds did not pay sufficient attention to liquidity risks.

### System-wide exploratory scenario (SWES) and continued monitoring
- FPC plans a system-wide exploratory scenario (SWES) exercise focused on NBFI risks—voluntary but intended to cover most systemic NBFIs and their links to banks, including those domiciled abroad and core markets.
- SWES aims to identify and possibly quantify risks including hidden leverage and channels of systemic risk propagation; should help close some NBFI data gaps and inform stronger regulation and supervision.
- Continued horizon scanning required: NBFI sector is diverse, evolving, and adapting; monitoring and assessment improvements are necessary to identify vulnerabilities and respond to stress.

### Conclusions and policy implications
- LDI stress episode echoed recurring NBFI vulnerabilities: liquidity stress, leverage, and interconnectedness.
- BoE intervention restored market functioning and provided time for LDI funds to build more resilient positions, but further lessons remain.
- Episode triggered by a fiscal event producing historical gilt yield moves, exceeding standard stress test parameters—highlights importance of macroeconomic policy coordination and the use of reverse stress testing to identify extreme events and develop contingency plans.
- Market intelligence is critical when data are unavailable or not timely; SWES can contribute to real-time decision-making capabilities.
- Cross-border nature of NBFI activities necessitates international coordination to address vulnerabilities and avoid regulatory arbitrage.
- Clear and regular communication among regulators and to the public is essential, particularly to explain actions when perceived tensions arise between monetary policy and financial stability.

*Source: sipea2023049 - section 18.*

---


_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2023/english/sipea2023049.pdf_