## 1. INTRODUCTION

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### Market episode and immediate drivers
- Market stress centered on Liability-Driven Investment (LDI) funds followed the UK "mini-budget" announcement in September 2022.
- A sudden and sharp increase in gilt yields forced defined benefit (DB) pension funds with leveraged LDI strategies to quickly raise cash to meet margin and collateral calls, contributing to fire-sales of longer-dated gilts.
- The effect was compounded by rising long-term interest rates in the preceding 10 months, to which some pension schemes and LDI funds had failed to adjust their available liquidity resources.
- Imminent financial stability risks prompted a temporary and targeted Bank of England (BoE) intervention in the gilt market to restore orderly market conditions and allow LDI funds time to recapitalize.
- Core features of the turmoil: leverage, liquidity mismatches between assets and liabilities, and concentrated positions of LDI strategies.

### NBFI sector characterization and systemic relevance
- Definition and scope:
  - NBFIs comprise financial intermediaries that are not banks, central banks, or public financial institutions; they include insurers, pension funds, various types of investment funds, finance companies, broker-dealers, and central counterparties (CCPs).
  - NBFIs are not deposit takers and are generally not subject to bank-like regulation or supervision and generally do not have access to central bank backstops.
- FSB “narrow measure”:
  - Subset of NBFIs involved in credit intermediation activities (maturity/liquidity transformation, leverage or imperfect credit risk transfer, and/or regulatory arbitrage) that may pose bank-like financial stability risks.
- Rising weight and interconnectedness in the UK:
  - NBFI financial assets ≈ half of total UK financial assets as of end-2021, up from ≈ 45 percent a decade earlier.
  - NBFI lending expanded domestically and across borders: 37 percent in total non-financial corporate lending, 11 percent in specific mortgage products, and 52 percent in unsecured consumer credit.
  - Nearly half of funding of UK finance companies comes from banks.
  - Liquidity mismatches in internationally active NBFIs were identified as the main source of risk in core sterling markets per the 2022 UK FSAP.

### Major NBFI sub-sectors (high-level)
- Pension funds
  - Est. AUM* (end-2021): $4.1tn
  - Main activities: Invest client contributions in public and private markets. Defined benefit pension funds often make use of leverage to match liabilities to assets.
  - Relevant regulator/supervisor (if domiciled in UK): The Pension Regulator (TPR) (DB pensions); DC schemes jointly regulated with Financial Conduct Authority (FCA)
  - Potential source of financial stability risk: Leverage in core markets
- Insurance companies
  - Est. AUM* (end-2021): $3.2tn
  - Main activities: Invest premia with aim of providing financial protection.
  - Relevant regulator/supervisor: FCA & Prudential Regulatory Authority (PRA)
  - Potential source of financial stability risk: Links between banks and insurers
- Hedge funds
  - Est. AUM* (end-2021): $10.4tn**
  - Main activities: Invest client funds in a range of assets to maximize investor returns by making use of leverage.
  - Relevant regulator/supervisor: Fund managers are authorized and regulated by the FCA
  - Potential source of financial stability risk: Leverage
- Exchange-traded funds (ETFs)
  - Main activities: Typically, secondary-market trading of shares, redeemable in kind.
  - Relevant regulator/supervisor: FCA
  - Potential source of financial stability risk: Liquidity mismatch in fixed-income ETFs.
- Open-ended funds
  - Main activities: Investor money pooled and invested into various assets. Redemption offered in short term (typically daily).
  - Relevant regulator/supervisor: FCA
  - Potential source of financial stability risk: Liquidity mismatch; systemic risk – notably cross border linkages
- Money market funds (MMFs)
  - Main activities: Bring together demand and supply for short-term funding
  - Relevant regulator/supervisor: FCA
  - Potential source of financial stability risk: Liquidity mismatch; systemic stress in short-term funding markets
- Real estate funds
  - Main activities: Invest client contributions in illiquid real estate assets
  - Relevant regulator/supervisor: FCA
  - Potential source of financial stability risk: Liquidity mismatch
- Securitizations
  - Main activities: Convert a vast range of illiquid assets into more tradable and accessible securities
  - Relevant regulator/supervisor: PRA and FCA
  - Potential source of financial stability risk: Credit risk
- Broker-dealers
  - Main activities: Facilitate client trades e.g. derivatives, enable leverage.
  - Relevant regulator/supervisor: FCA
  - Potential source of financial stability risk: Market intermediation dependent on short-term funding
- Central counterparties (CCPs)
  - Main activities: Netting of risk by acting as the central counterparty to holders of financial contracts.
  - Relevant regulator/supervisor: Bank of England
  - Potential source of financial stability risk: Liquidity stress amplification; commodity traders
- Commodity traders
  - Main activities: Take positions to hedge activity in physical markets; could use derivatives to speculate on changes in commodity prices.
  - Relevant regulator/supervisor: Generally unregulated, given client-facing activities.
  - Potential source of financial stability risk: Liquidity risk, credit risk
- Notes:
  - * Assets under management values are based on the FSB Global Monitoring Report on Non-Bank Financial Intermediaries 2022
  - ** Value denotes size of Other Financial Intermediaries (OFIs), i.e., assets of all financial institutions that are not central banks, insurers, pension funds, public financial institutions or financial auxiliaries.

### The evolution and mechanics of LDI strategies in the UK
- Regulatory and demographic drivers since the late 1990s:
  - Changes to accounting standards (FRS17 and IAS19) required corporates to include pension deficits on corporate balance sheets.
  - Increasing life expectancy lengthened pension payment horizons; many employers closed DB schemes to new members and shifted to DC schemes.
  - Active members in private DB schemes: decreased from 3 million in 2006 to 0.9 million in 2019.
  - Active members in DC schemes: increased from 1 million to 10.6 million over the same period.
  - DB schemes still held close to 90 percent of total private pension funds’ assets as of mid-2022.
- Asset allocation shifts:
  - Share of equity investment in DB fund assets declined from about 61 percent in 2006 to about 20 percent in 2022.
  - Share of fixed-income investments increased from 28 percent to 72 percent.
- Purpose and mechanics of LDI:
  - LDI strategies are used to match market exposure of assets to liabilities while freeing funds to invest in growth assets.
  - Leverage is obtained through repurchase agreements and derivatives (e.g., interest rate swaps), increasing exposure to long-term gilts and hedging interest rate and inflation risk.
  - Leverage requires collateral (generally a combination of cash and gilts) to be posted against repo or derivative contracts.
  - If interest rates fall, LDI returns profit to offset rising present value of pension liabilities; if interest rates rise, liabilities decline in present value but LDI strategies can incur losses requiring collateral or cash margins.
- Growth and market concentration:
  - 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), per the Investment Association.
  - LDI strategies in the UK are highly concentrated: the top three LDI asset managers represent 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, per the Pension Regulator.
  - In pooled funds, exhaustion of liquidity buffers forces asset managers to send margin calls to pension funds’ trustees, who may take one to two weeks to raise cash; otherwise, positions can be liquidated by LDI fund managers, involving selling underlying gilts.

### Purpose and organization of the paper
- Objectives:
  - Draw lessons from the LDI stress episode to mitigate and manage financial stability risks associated with the broader NBFI sector.
  - Understand drivers of the market turmoil and the BoE’s financial stability intervention, including coordination, instrument choice, and communication that led to its success.
  - Explore limits to regulation and supervision of pension funds and LDI strategies.
  - Propose takeaways for monitoring and mitigating financial stability risks in the NBFI sector, drawing on the episode and the 2022 UK FSAP findings.
- Organization:
  - Section II: historical background for popularity of LDI strategies among UK DB pension funds and implications for gilt market.
  - Section III: unfolding of the LDI crisis and BoE’s financial stability interventions; draws on discussions with market participants and UK authorities.
  - Section IV: key takeaways.
- Note:
  - Vulnerabilities revealed in the LDI crisis are not unique to UK pension funds and are shared by the wider NBFI sector, including in other countries.

### Recent financial stress episodes involving NBFIs (selected)
- Dash for Cash (March 2020)
  - Pandemic-related restrictions led to a “dash for cash”; major central banks used asset purchases to support market functioning as precautionary demand for liquidity surged.
  - In the UK, demand to transact in the gilt market increased for insurance companies, pension funds, LDI asset managers, other asset managers, hedge funds, and the foreign official sector.
  - NBFIs’ use of sterling repo markets increased sharply; liquidity demands were driven by margin calls on derivative exposures, large redemptions from open-ended and money market funds, and precautionary liquidity hoarding.
  - The BoE augmented repo operations and front-loaded bond purchases to support market liquidity.
- Archegos (March 2021)
  - Archegos Capital Management failed to meet margin calls after a sharp drop in value of large positions in equity derivatives funded by borrowing from several global banks.
  - The failure led counterparties to sell securities used to hedge exposures, contributing to further margin calls and deleveraging.
  - Reported losses across multiple firms exceeded $10 billion.
  - Example: Credit Suisse International and Credit Suisse Securities (Europe) Ltd booked around $5.1 billion of losses when Archegos defaulted.
  - PRA announced in July 2023 that it imposed a fine of £87 million on Credit Suisse International and Credit Suisse Securities (Europe) Ltd for significant failures in risk management and governance related to exposures to Archegos Capital Management.

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### 3. The LDI Crisis and Bank of England’s Financial Stability Intervention

### 3.A The Unfolding of the LDI Crisis
- Policy and market shock
  - The September 23 "mini-budget" announced £45 billion unfunded tax cuts amid historically high inflation and increasing yields.
  - The "mini-budget" was not accompanied by an assessment by the Office for Budget Responsibility (OBR).
- Market reaction and immediate dynamics
  - The pound fell to its lowest-ever level on record (1.03) against the dollar by the following trading day.
  - The 30-year gilt yield jumped by an historic 140 basis points over three days.
  - Rapid increase in gilt yields caused significant falls in net asset value of LDI funds, forcing quick cash raising to post additional collateral on secured borrowing and to meet higher margin calls.
- Operational constraints and fire-sale dynamics
  - Segregated LDI account managers had ready access to additional assets and cash; pooled LDI funds with many small DB pension fund investors faced operational challenges mobilizing extra liquidity.
  - Market liquidity deteriorated rapidly (measured by bid-ask spreads); without cash to meet margin and collateral calls, pooled LDI funds attempted to sell gilts, contributing to fire-sale dynamics.
  - Forced selling of long-dated and index-linked gilts in an increasingly illiquid market pushed yields higher and increased required collateral payments.
- Broader market and real-economy spillovers
  - Other assets, including MMFs and investments in open-ended funds, were also liquidated; some real estate funds had to suspend redemptions while MMFs were able to meet redemptions.
  - Swap rates spiked; the 2-yr interest rate swap typically used to price mortgage products reached 6% in the aftermath of the mini-budget.
  - Several mortgage providers temporarily discontinued mortgage offerings as it became difficult to price markets.

### 3.B The Bank of England’s Financial Stability Intervention
- Rationale and design
  - On September 28 the BoE announced a temporary and targeted purchase of long-term gilts, describing that "multiple LDI funds were likely to fall into negative net asset value," risking a self-reinforcing spiral and severe disruption of core funding markets.
  - The operation: 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, implying the BoE backstop would provide sufficient liquidity.
  - The BoE framed the operation as backstop pricing (reserve pricing) to remove the liquidity premium without distorting market prices.
- Coordination and constraints
  - The intervention followed recommendation from the Financial Policy Committee (FPC); the Bank Executive decided to intervene. HM Treasury provided full indemnification.
  - The Prudential Regulation Authority (PRA), the Pensions Regulator (TPR), and the Financial Conduct Authority (FCA) monitored rebalancing progress; regulators in Ireland and Luxembourg were in close contact.
  - The Monetary Policy Committee (MPC) was informed that the operation was targeted and temporary and assessed that it would not shift underlying inflation dynamics or interfere with monetary policy operations.
  - Market intelligence indicated high leverage and that fund managers were struggling to sell assets into a thin market, necessitating swift intervention.
  - A repo facility with LDI funds was ruled out because LDI funds needed to deleverage (not re-leverage), and a repo would have provided only funding liquidity, not market stability.
  - The BoE used a maximum daily limit (£5 billion) to provide credibility to the backstop rather than a target purchase amount as in QE operations.
- Expansion of measures during the operation
  - 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, and committed to maintaining liquidity support through its regular Repo operations.
  - The TECRF proved less attractive; reported total take-up of the TECRF was very small, at only £5.75 million.
- Exit considerations and moral hazard
  - Approaching the October 14 expiration, markets were anxious about a "cliff edge"; Governor Bailey communicated the intervention would end as planned and urged pension funds to rebalance.
  - The BoE insisted on the temporary nature of the intervention to avoid moral hazard and to preserve incentives for LDI funds and pension funds to accept losses and rebalance.
- Interaction with fiscal policy and market outcomes
  - Reversals of key "mini-budget" measures between October 3–17 helped calm markets: then-PM Truss dropped some measures and on October 14 appointed Jeremy Hunt as chancellor; on October 17 the new chancellor scrapped most remaining tax cuts.
  - The intervention initially calmed markets—the 30-year gilt yield dropped more than 100 bps on the first day—but yields rose again until fiscal policy concerns were addressed.
- Results, sales, and unwind
  - 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 of index-linked gilts
  - DB pension schemes and LDI funds sold an estimated £37 billion in gilts over this period.
  - Total margin and collateral calls faced by these entities over this period were roughly £70 billion.
  - LDI funds and pension schemes also sold assets other than gilts (such as equities or corporate bonds) and used existing cash buffers to meet obligations.
  - Market intelligence suggests LDI funds also raised tens of billion pounds in capital from end-investors, reducing leverage.
  - The BoE fully unwound all its financial stability gilt purchases by January 12, 2023, three months after the end of the stability intervention.
  - The Bank commenced its QT in early November and maintained its annual target of £80 billion reduction of its Asset Purchase Facility (APF) gilt holdings for monetary policy purposes; long-dated gilts were initially excluded from QT sales and later included from January 2023.

### Key timeline highlights (selected dates and cumulative changes in long-term gilts since September 21 shown in square brackets)
- September 22, 2022: BoE hiked its policy rate by 50bps; [Long-term gilt yields rose by 19 bps]
- September 23, 2022: The "mini-budget" was announced; sterling fell by around 4 percent against US dollar; [+27 bps]
- September 26, 2022: Sterling plunged to 1.03 against the dollar; Long-term gilt yields rose by 50 bps; [+95 bps]
- September 27, 2022: 30-year gilt yields increased by about 70 bps by end of trading; [+140 bps]
- September 28, 2022: BoE announced gilt market operation; 30-year gilt yields fell by more than 100 bps after announcement; [+34 bps]
- October 10, 2022: BoE announced additional measures (increased auction size; TECRF); [+110 bps]
- October 11, 2022: BoE widened gilt purchases to include index-linked gilts; [+121 bps]
- October 14, 2022: Bank terminated gilt market operations and ceased all bond purchases; [+119 bps]
- November 1, 2022: Gilt sale operation starts in the short-maturity sector; [-10 bps]
- November 10, 2022: BoE set out plans to unwind recent financial stability gilt purchases in a timely but orderly way; [-18 bps]
- January 12, 2023: BoE completed its sales of the £19.3 billion portfolio; [-8 bps]

---

### 4. Key Takeaways

### 4.A Regulatory and information gaps
- Visibility and regulatory oversight gaps:
  - UK regulators have limited visibility and regulatory oversight of pooled and single client funds where leverage and liquidity data are not readily available.
  - The PRA regulates bank counterparties of LDI funds, but the BoE does not directly regulate pension funds, LDI managers, or LDI funds.
  - Pension schemes are regulated by TPR and LDI managers by the FCA.
  - Investment funds operating LDI strategies are largely based in Ireland and Luxembourg; information is reported via UK AIFMD given marketing to UK investors, but data quality and availability are challenging and reporting is done with a lag.
  - The FCA noted limited data on the use of LDI strategies, leverage, and collateral.
  - The FSAP could not evaluate the liquidity risks of LDI funds domiciled outside the UK.
- Need for expanded data and reporting:
  - FSAP recommended collecting or systematizing reporting of data for all Sterling holdings by all investors to analyze concentration of NBFI investors in key sterling markets and implications for market liquidity.
  - More granular data and a monitoring framework are needed to analyze combined liquidity drains, including insurer policy surrenders, catastrophe events, and lower premiums.
  - PRA should enhance supervisory reporting and monitor cash pooling arrangements within insurance groups.
  - Intermediaries such as prime brokers should have access to data on a fund’s overall leverage, not just the portion to which they have contributed.
- International coordination and information sharing:
  - UK NBFI sector is internationally connected; information collection and supervision require international cooperation.
  - ESRB uses AIFMD reporting to analyze NBFI risks; all UK pooled LDI fund managers are domiciled in the EU and their information can be accessed through AIFMD data.
  - UK authorities should seek regular access to AIFMD data through a bilateral agreement with EU authorities and explore other sources for higher frequency data.
  - FCA is reportedly receiving information from LDI managers on a more frequent basis now.
- Policy implication:
  - Consideration should be given to limiting concentrated exposures and correlated behaviors that can strain market functioning and threaten financial stability through enhanced efforts to close information and data gaps.

### 4.B NBFIs’ liquidity management and oversight of leverage
- Mechanisms of amplification:
  - Liquidity shortages, leveraged positions, and high interconnectedness amplify financial stability vulnerabilities; LDI fund selling of gilts during margin calls demonstrated rapid stress amplification.
  - Similar dynamics observed in the Dash for Cash and Archegos episodes.
- Failures in risk management and stress testing:
  - According to the 2019 TPR survey, only 55 percent of pension schemes used interest rate shocks to estimate potential collateral needs; the average interest rate movement used was 291 bps.
  - Inflation shocks were used by 47 percent of schemes.
  - LDI managers controlled collateral management for 59 percent of schemes.
  - Staff assumption: assumed stress durations in stress tests likely longer than the rapid yield increases realized in the market.
- Strengthening liquidity regulation and buffers:
  - Mandated liquidity buffers for NBFIs should be reevaluated and strengthened if required; stress tests were too mild.
  - Following the crisis, funds secured an average yield buffer (“headroom”) of around 300-400 bps.
  - Ongoing work on liquidity mismatches in investment funds is important; money market and open-ended fund regulation should be enhanced in line with recent FSB proposals.
  - MMF policy proposals include reducing liquidity transformation (holding a higher share of liquid assets) and moving the cost of redeeming to redeeming investors (e.g., swing pricing).
  - Ensure open-ended funds use adequate liquidity management tools; UK authorities published a discussion paper in May 2022 with potential policy options for MMFs, including reducing liquidity transformation and use of liquidity management tools (LMTs).
- Ex-ante liquidity facilities:
  - Ex-ante liquidity facilities for NBFIs, such as pre-negotiated contingent liquidity lines with banks, could be considered.
  - The repo window the BoE set up would have involved banks but did not work during stress; banks are unlikely to provide liquidity to NBFIs during a crisis given more stringent post-GFC regulations.
  - Pre-negotiated contingency liquidity lines are precedent in Denmark.
- Regulatory responses and guidance:
  - TPR set out a minimum liquidity requirement for pension funds investing in LDI strategies to withstand a 250 bps move in long-dated gilt yields, substantially higher than the 140 bps increase in long-term yields seen in a few days during the LDI crisis.
  - FCA and TPR issued guidance on enhancing resilience in LDI funds: realistic contingency planning, appropriately designed stress tests, and ensuring clients can deliver collateral within five days.
  - Overseas regulators of pound-denominated LDI funds engaged with fund managers to improve resilience across Europe (CBI, 2022).

### 4.C Central bank liquidity backstops for systemic NBFIs
- Role of market intelligence in BoE intervention:
  - Timely market intelligence helped tailor the BoE’s response; confirmed high leverage and the need for swift intervention.
  - A repo facility for LDI funds was ruled out; targeted gilt purchases were chosen as the best option.
- Design and communication of interventions:
  - BoE intervened by pausing planned active gilt sales and setting backstop pricing relative to market prices, purchasing only as much as required to restore orderly functioning.
  - Central bank asset purchases during a tightening cycle can complicate price stability goals and raise moral hazard concerns.
  - Transparency and clear communication are critical when opening central bank liquidity support to NBFIs, especially if measures are prolonged and untargeted.
  - BoE’s firm communication on the temporary and targeted nature of the intervention and on the need for pension fund recapitalization was critical.
- Expanding central bank operational frameworks:
  - For entities with collected data, appropriate supervision, and systemic interconnectedness, consideration could be given to grant access to a central bank liquidity backstop focused on maintaining functioning of core markets (such as gilts and gilt repos).
  - Inclusion of certain NBFIs in the BoE’s operational framework could improve options in future stress situations.
  - Design of facilities should reflect NBFIs’ diverse nature and include safeguards keeping risk in the marketplace to avoid moral hazard.

### 4.D Overall surveillance of the NBFI sector
- Limits of prior stress analyses:
  - FPC’s past stress analysis underestimated extremes; a 2018 FPC assessment concluded most non-banks had sufficient liquid assets for a 100 bps interest rate shock, noting “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 move in late September exceeded this and liquidity shortfalls increased exponentially.
  - The FPC’s 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 market turmoil, pension funds raised £40 billion in cash, whereas 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) exercise:
  - FPC’s planned SWES focused on NBFI risks is a welcome step to improve understanding of NBFI-related vulnerabilities.
  - The voluntary exercise intends to cover most systemic NBFIs and their links to banks, both domestic and domiciled abroad, and core markets.
  - SWES should help identify and possibly quantify risks including hidden leverage and channels of systemic risk propagation, and help close some NBFI data gaps.
- Ongoing monitoring:
  - Continued horizon scanning is required because the NBFI sector is diverse, evolving, and adapting; continued monitoring and improved assessments are required.

### Concluding points
- The LDI stress episode echoes past NBFI vulnerabilities—liquidity stress, leverage, and interconnectedness—and was not completely idiosyncratic.
- The episode was triggered by a fiscal event resulting in historical moves in gilt yields that exceeded standard stress test parameters; reverse stress testing can help identify extreme scenarios and develop contingency plans and risk mitigation strategies.
- Market intelligence complemented available data during the crisis and was key for real-time decision-making; SWES could contribute by identifying key market players and behavior under stress.
- Cross-border nature of NBFI activities requires international coordination to address vulnerabilities and avoid regulatory arbitrage.
- Clear and regular communication among regulators and with the public is crucial, especially given perceived tensions between monetary policy and financial stability; timely communication helps market participants understand the purpose of authorities’ actions.

*Source: IMF Working Paper — "Putting Out the NBFire", 1. INTRODUCTION; Chapter 3; Section 4. Key Takeaways (content unit: wpiea2023210-print-pdf).*

### 1. INTRODUCTION _______________________________________________________________________________  4

### 1. INTRODUCTION

### Market episode and immediate drivers
- Market stress centered on Liability-Driven Investment (LDI) funds followed the UK "mini-budget" announcement in September 2022.
- A sudden and sharp increase in gilt yields forced defined benefit (DB) pension funds with leveraged LDI strategies to quickly raise cash to meet margin and collateral calls, contributing to fire-sales of longer-dated gilts.
- The effect was compounded by rising long-term interest rates in the preceding 10 months, to which some pension schemes and LDI funds had failed to adjust their available liquidity resources.
- Imminent financial stability risks prompted a temporary and targeted Bank of England (BoE) intervention in the gilt market to restore orderly market conditions and allow LDI funds time to recapitalize.
- Core features of the turmoil: leverage, liquidity mismatches between assets and liabilities, and concentrated positions of LDI strategies.

### NBFI sector characterization and systemic relevance
- Definition: NBFIs comprise financial intermediaries that are not banks, central banks, or public financial institutions; they include insurers, pension funds, various types of investment funds, finance companies, broker-dealers, and central counterparties (CCPs).
- Distinctions from banks:
  - NBFIs are not deposit takers and are generally not subject to bank-like regulation or supervision.
  - NBFIs generally do not have access to central bank backstops.
- Financial Stability Board (FSB) “narrow measure”: subset of NBFIs assessed as involved in credit intermediation activities (maturity/liquidity transformation, leverage or imperfect credit risk transfer, and/or regulatory arbitrage) and that may pose bank-like financial stability risks.
- Rising weight and interconnectedness in the UK:
  - NBFI financial assets ≈ half of total UK financial assets as of end-2021, up from ≈ 45 percent a decade earlier.
  - NBFI lending expanded domestically and across borders, notably in CRE and SME sectors (37 percent in total non-financial corporate lending), specific mortgage products (11 percent), and unsecured consumer credit (52 percent).
  - Nearly half of funding of UK finance companies comes from banks.
  - Liquidity mismatches in internationally active NBFIs were identified as the main source of risk in core sterling markets (equity, corporate bonds, commercial papers, gilts) per the 2022 UK FSAP.

### Table of major NBFI sub-sectors (as provided)
- Pension funds
  - Est. AUM* (end-2021): $4.1tn
  - Main activities: Invest client contributions in public and private markets. Defined benefit pension funds often make use of leverage to match liabilities to assets.
  - Relevant regulator/supervisor (if domiciled in UK): The Pension Regulator (TPR) (DB pensions); DC schemes jointly regulated with Financial Conduct Authority (FCA)
  - Potential source of financial stability risk (not exhaustive): Leverage in core markets
- Insurance companies
  - Est. AUM* (end-2021): $3.2tn
  - Main activities: Invest premia with aim of providing financial protection.
  - Relevant regulator/supervisor: FCA & Prudential Regulatory Authority (PRA)
  - Potential source of financial stability risk: Links between banks and insurers
- Hedge funds
  - Est. AUM* (end-2021): $10.4tn**
  - Main activities: Invest client funds in a range of assets to maximize investor returns by making use of leverage.
  - Relevant regulator/supervisor: Fund managers are authorized and regulated by the FCA
  - Potential source of financial stability risk: Leverage
- Exchange-traded funds (ETFs)
  - Main activities: Typically, secondary-market trading of shares, redeemable in kind.
  - Relevant regulator/supervisor: FCA
  - Potential source of financial stability risk: Liquidity mismatch in fixed-income ETFs.
- Open-ended funds
  - Main activities: Investor money pooled and invested into various assets. Redemption offered in short term (typically daily).
  - Relevant regulator/supervisor: FCA
  - Potential source of financial stability risk: Liquidity mismatch; systemic risk – notably cross border linkages
- Money market funds (MMFs)
  - Main activities: Bring together demand and supply for short-term funding
  - Relevant regulator/supervisor: FCA
  - Potential source of financial stability risk: Liquidity mismatch; systemic stress in short-term funding markets
- Real estate funds
  - Main activities: Invest client contributions in illiquid real estate assets
  - Relevant regulator/supervisor: FCA
  - Potential source of financial stability risk: Liquidity mismatch
- Securitizations
  - Main activities: Convert a vast range of illiquid assets into more tradable and accessible securities
  - Relevant regulator/supervisor: PRA and FCA
  - Potential source of financial stability risk: Credit risk
- Broker-dealers
  - Main activities: Facilitate client trades e.g. derivatives, enable leverage.
  - Relevant regulator/supervisor: FCA
  - Potential source of financial stability risk: Market intermediation dependent on short-term funding
- Central counterparties (CCPs)
  - Main activities: Netting of risk by acting as the central counterparty to holders of financial contracts.
  - Relevant regulator/supervisor: Bank of England
  - Potential source of financial stability risk: Liquidity stress amplification; commodity traders
- Commodity traders
  - Main activities: Take positions to hedge activity in physical markets; could use derivatives to speculate on changes in commodity prices.
  - Relevant regulator/supervisor: Generally unregulated, given client-facing activities.
  - Potential source of financial stability risk: Liquidity risk, credit risk

- Notes included in table:
  - * Assets under management values are based on the FSB Global Monitoring Report on Non-Bank Financial Intermediaries 2022
  - ** Value denotes size of Other Financial Intermediaries (OFIs), i.e., assets of all financial institutions that are not central banks, insurers, pension funds, public financial institutions or financial auxiliaries.
  - Footnotes clarifying UK regulatory roles for DC and DB schemes, and the scope of FCA supervision for hedge funds and broker-dealer regulation.

### The evolution and mechanics of LDI strategies in the UK
- Regulatory and demographic drivers since the late 1990s:
  - Changes to accounting standards (FRS17 and IAS19) required corporates to include pension deficits on corporate balance sheets.
  - Increasing life expectancy lengthened pension payment horizons; many employers closed DB schemes to new members and shifted to DC schemes.
  - Active members in private DB schemes: decreased from 3 million in 2006 to 0.9 million in 2019.
  - Active members in DC schemes: increased from 1 million to 10.6 million over the same period.
  - DB schemes still held close to 90 percent of total private pension funds’ assets as of mid-2022.
- Asset allocation shifts:
  - Share of equity investment in DB fund assets declined from about 61 percent in 2006 to about 20 percent in 2022.
  - Share of fixed-income investments increased from 28 percent to 72 percent.
- Purpose and mechanics of LDI:
  - LDI strategies are used to match market exposure of assets to liabilities while freeing funds to invest in growth assets.
  - Leverage is obtained through repurchase agreements and derivatives (e.g., interest rate swaps), increasing exposure to long-term gilts and hedging interest rate and inflation risk.
  - Leverage requires collateral (generally a combination of cash and gilts) to be posted against repo or derivative contracts.
  - If interest rates fall, LDI returns profit to offset rising present value of pension liabilities; if interest rates rise, liabilities decline in present value but LDI strategies can incur losses requiring collateral or cash margins.
- Growth and market concentration:
  - 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), per the Investment Association.
  - LDI strategies in the UK are highly concentrated: the top three LDI asset managers represent roughly 70 percent of the LDI market.
  - Pooled LDI funds (cost-effective for smaller pension funds) make up between 10-15% of the LDI market; there are about 175 pooled LDI funds with about 1800 pension schemes participating, per the Pension Regulator.
  - In pooled funds, exhaustion of liquidity buffers forces asset managers to send margin calls to pension funds’ trustees, who may take one to two weeks to raise cash; otherwise, positions can be liquidated by LDI fund managers, involving selling underlying gilts.

### Purpose and organization of the paper
- Objectives:
  - Draw lessons from the LDI stress episode to mitigate and manage financial stability risks associated with the broader NBFI sector.
  - Understand drivers of the market turmoil and the BoE’s financial stability intervention, including coordination, instrument choice, and communication that led to its success.
  - Explore limits to regulation and supervision of pension funds and LDI strategies.
  - Propose takeaways for monitoring and mitigating financial stability risks in the NBFI sector, drawing on the episode and the 2022 UK FSAP findings.
- Organization:
  - Section II: historical background for popularity of LDI strategies among UK DB pension funds and implications for gilt market.
  - Section III: unfolding of the LDI crisis and BoE’s financial stability interventions; draws on discussions with market participants and UK authorities.
  - Section IV: key takeaways.
  - The paper notes that vulnerabilities revealed in the LDI crisis are not unique to UK pension funds and are shared by the wider NBFI sector, including in other countries.

### Recent financial stress episodes involving NBFIs (Box 1)
- Dash for Cash (March 2020)
  - Pandemic-related restrictions led to a “dash for cash”; major central banks used asset purchases to support market functioning as precautionary demand for liquidity surged.
  - In the UK, demand to transact in the gilt market increased for insurance companies, pension funds, LDI asset managers, other asset managers, hedge funds, and the foreign official sector.
  - NBFIs’ use of sterling repo markets increased sharply; liquidity demands were driven by margin calls on derivative exposures, large redemptions from open-ended and money market funds, and precautionary liquidity hoarding.
  - The BoE (together with peer central banks) augmented repo operations and front-loaded bond purchases to support market liquidity.
- Archegos (March 2021)
  - A US family office, Archegos Capital Management, failed to meet margin calls after a sharp drop in value of large positions in equity derivatives funded by borrowing from several global banks.
  - The failure led counterparties to sell securities used to hedge exposures, contributing to further margin calls and deleveraging.
  - Reported losses across multiple firms exceeded $10 billion.
  - Example: Credit Suisse International and Credit Suisse Securities (Europe) Ltd booked around $5.1 billion of losses when Archegos defaulted.
  - Regulatory scrutiny followed; PRA announced in July 2023 that it imposed a fine of £87 million on Credit Suisse International and Credit Suisse Securities (Europe) Ltd for significant failures in risk management and governance related to exposures to Archegos Capital Management.

*Source: IMF Working Paper — "Putting Out the NBFire", 1. INTRODUCTION (content unit: wpiea2023210-print-pdf).*

### 3. The LDI Crisis and Bank of England’s

### 3. The LDI Crisis and Bank of England’s Financial Stability Intervention

### 3.A The Unfolding of the LDI Crisis
- Policy and market shock
  - The September 23 "mini-budget" announced £45 billion unfunded tax cuts amid historically high inflation and increasing yields.
  - The "mini-budget" was not accompanied by an assessment by the Office for Budget Responsibility (OBR).
- Market reaction and immediate dynamics
  - The pound fell to its lowest-ever level on record (1.03) against the dollar by the following trading day.
  - The 30-year gilt yield jumped by an historic 140 basis points over three days.
  - Rapid increase in gilt yields caused significant falls in net asset value of LDI funds, forcing quick cash raising to post additional collateral on secured borrowing and to meet higher margin calls.
- Operational constraints and fire-sale dynamics
  - Segregated LDI account managers had ready access to additional assets and cash; pooled LDI funds with many small DB pension fund investors faced operational challenges mobilizing extra liquidity.
  - Market liquidity deteriorated rapidly (measured by bid-ask spreads); without cash to meet margin and collateral calls, pooled LDI funds attempted to sell gilts, contributing to fire-sale dynamics.
  - Forced selling of long-dated and index-linked gilts in an increasingly illiquid market pushed yields higher and increased required collateral payments.
- Broader market and real-economy spillovers
  - Other assets, including MMFs and investments in open-ended funds, were also liquidated; some real estate funds had to suspend redemptions while MMFs were able to meet redemptions.
  - Swap rates spiked; the 2-yr interest rate swap typically used to price mortgage products reached 6% in the aftermath of the mini-budget.
  - Several mortgage providers temporarily discontinued mortgage offerings as it became difficult to price markets.

### 3.B The Bank of England’s Financial Stability Intervention
- Rationale and design
  - On September 28 the BoE announced a temporary and targeted purchase of long-term gilts, describing that "multiple LDI funds were likely to fall into negative net asset value," risking a self-reinforcing spiral and severe disruption of core funding markets.
  - The operation: 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, implying the BoE backstop would provide sufficient liquidity.
  - The BoE framed the operation as backstop pricing (reserve pricing) to remove the liquidity premium without distorting market prices.
- Coordination and constraints
  - The intervention followed recommendation from the Financial Policy Committee (FPC); the Bank Executive decided to intervene. HM Treasury provided full indemnification.
  - The Prudential Regulation Authority (PRA), the Pensions Regulator (TPR), and the Financial Conduct Authority (FCA) monitored rebalancing progress; regulators in Ireland and Luxembourg were in close contact.
  - The Monetary Policy Committee (MPC) was informed that the operation was targeted and temporary and assessed that it would not shift underlying inflation dynamics or interfere with monetary policy operations.
  - Market intelligence indicated high leverage and that fund managers were struggling to sell assets into a thin market, necessitating swift intervention.
  - A repo facility with LDI funds was ruled out because LDI funds needed to deleverage (not re-leverage), and a repo would have provided only funding liquidity, not market stability.
  - The BoE used a maximum daily limit (£5 billion) to provide credibility to the backstop rather than a target purchase amount as in QE operations.
- Expansion of measures during the operation
  - 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, and committed to maintaining liquidity support through its regular Repo operations.
  - The TECRF proved less attractive; reported total take-up of the TECRF was very small, at only £5.75 million.
- Exit considerations and moral hazard
  - Approaching the October 14 expiration, markets were anxious about a "cliff edge"; Governor Bailey communicated the intervention would end as planned and urged pension funds to rebalance.
  - The BoE insisted on the temporary nature of the intervention to avoid moral hazard and to preserve incentives for LDI funds and pension funds to accept losses and rebalance.
- Interaction with fiscal policy and market outcomes
  - Reversals of key "mini-budget" measures between October 3–17 helped calm markets: then-PM Truss dropped some measures and on October 14 appointed Jeremy Hunt as chancellor; on October 17 the new chancellor scrapped most remaining tax cuts.
  - The intervention initially calmed markets—the 30-year gilt yield dropped more than 100 bps on the first day—but yields rose again until fiscal policy concerns were addressed.
- Results, sales, and unwind
  - 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 of index-linked gilts
  - DB pension schemes and LDI funds sold an estimated £37 billion in gilts over this period.
  - Total margin and collateral calls faced by these entities over this period were roughly £70 billion.
  - LDI funds and pension schemes also sold assets other than gilts (such as equities or corporate bonds) and used existing cash buffers to meet obligations.
  - Market intelligence suggests LDI funds also raised tens of billion pounds in capital from end-investors, reducing leverage.
  - The BoE fully unwound all its financial stability gilt purchases by January 12, 2023, three months after the end of the stability intervention.
  - The Bank commenced its QT in early November and maintained its annual target of £80 billion reduction of its Asset Purchase Facility (APF) gilt holdings for monetary policy purposes; long-dated gilts were initially excluded from QT sales and later included from January 2023.

### Key timeline highlights (selected dates and cumulative changes in long-term gilts since September 21 shown in square brackets)
- September 22, 2022: BoE hiked its policy rate by 50bps; [Long-term gilt yields rose by 19 bps]
- September 23, 2022: The "mini-budget" was announced; sterling fell by around 4 percent against US dollar; [+27 bps]
- September 26, 2022: Sterling plunged to 1.03 against the dollar; Long-term gilt yields rose by 50 bps; [+95 bps]
- September 27, 2022: 30-year gilt yields increased by about 70 bps by end of trading; [+140 bps]
- September 28, 2022: BoE announced gilt market operation; 30-year gilt yields fell by more than 100 bps after announcement; [+34 bps]
- October 10, 2022: BoE announced additional measures (increased auction size; TECRF); [+110 bps]
- October 11, 2022: BoE widened gilt purchases to include index-linked gilts; [+121 bps]
- October 14, 2022: Bank terminated gilt market operations and ceased all bond purchases; [+119 bps]
- November 1, 2022: Gilt sale operation starts in the short-maturity sector; [-10 bps]
- November 10, 2022: BoE set out plans to unwind recent financial stability gilt purchases in a timely but orderly way; [-18 bps]
- January 12, 2023: BoE completed its sales of the £19.3 billion portfolio; [-8 bps]

*Source: IMF Working Paper — Chapter 3: The LDI Crisis and Bank of England’s Financial Stability Intervention (content unit: wpiea2023210-print-pdf).*

### 4. Key Takeaways

### 4. Key Takeaways

### 4.A Regulatory and information gaps
- Visibility and regulatory oversight gaps:
  - UK regulators have limited visibility and regulatory oversight of pooled and single client funds where leverage and liquidity data are not readily available.
  - The Prudential Regulation Authority (PRA) regulates bank counterparties of LDI funds, but the BoE does not directly regulate pension funds, LDI managers, or LDI funds.
  - Pension schemes are regulated by TPR and LDI managers by the Financial Conduct Authority (FCA).
  - Investment funds operating LDI strategies are largely based in Ireland and Luxembourg; information is reported via UK AIFMD given marketing to UK investors, but data quality and availability are challenging and reporting is done with a lag.
  - The FCA noted limited data on the use of LDI strategies, leverage, and collateral.
  - The FSAP could not evaluate the liquidity risks of LDI funds domiciled outside the UK.
- Need for expanded data and reporting:
  - FSAP recommended collecting or systematizing reporting of data for all Sterling holdings by all investors to analyze concentration of NBFI investors in key sterling markets and implications for market liquidity.
  - More granular data and a monitoring framework are needed to analyze combined liquidity drains, including insurer policy surrenders, catastrophe events, and lower premiums.
  - PRA should enhance supervisory reporting and monitor cash pooling arrangements within insurance groups.
  - Intermediaries such as prime brokers should have access to data on a fund’s overall leverage, not just the portion to which they have contributed.
- International coordination and information sharing:
  - UK NBFI sector is internationally connected; information collection and supervision require international cooperation.
  - ESRB uses AIFMD reporting to analyze NBFI risks; all UK pooled LDI fund managers are domiciled in the EU and their information can be accessed through AIFMD data.
  - UK authorities should seek regular access to AIFMD data through a bilateral agreement with EU authorities and explore other sources for higher frequency data.
  - FCA is reportedly receiving information from LDI managers on a more frequent basis now.
- Policy implication:
  - Consideration should be given to limiting concentrated exposures and correlated behaviors that can strain market functioning and threaten financial stability through enhanced efforts to close information and data gaps.

### 4.B NBFIs’ liquidity management and oversight of leverage
- Mechanisms of amplification:
  - Liquidity shortages, leveraged positions, and high interconnectedness amplify financial stability vulnerabilities; LDI fund selling of gilts during margin calls demonstrated rapid stress amplification.
  - Similar dynamics observed in the Dash for Cash and Archegos episodes.
- Failures in risk management and stress testing:
  - According to the 2019 TPR survey, only 55 percent of pension schemes used interest rate shocks to estimate potential collateral needs; the average interest rate movement used was 291 bps.
  - Inflation shocks were used by 47 percent of schemes.
  - LDI managers controlled collateral management for 59 percent of schemes.
  - Staff assumption: assumed stress durations in stress tests likely longer than the rapid yield increases realized in the market.
- Strengthening liquidity regulation and buffers:
  - Mandated liquidity buffers for NBFIs should be reevaluated and strengthened if required; stress tests were too mild.
  - Following the crisis, funds secured an average yield buffer (“headroom”) of around 300-400 bps.
  - Ongoing work on liquidity mismatches in investment funds is important; money market and open-ended fund regulation should be enhanced in line with recent FSB proposals.
  - MMF policy proposals include reducing liquidity transformation (holding a higher share of liquid assets) and moving the cost of redeeming to redeeming investors (e.g., swing pricing).
  - Ensure open-ended funds use adequate liquidity management tools; UK authorities published a discussion paper in May 2022 with potential policy options for MMFs, including reducing liquidity transformation and use of liquidity management tools (LMTs).
- Ex-ante liquidity facilities:
  - Ex-ante liquidity facilities for NBFIs, such as pre-negotiated contingent liquidity lines with banks, could be considered.
  - The repo window the BoE set up would have involved banks but did not work during stress; banks are unlikely to provide liquidity to NBFIs during a crisis given more stringent post-GFC regulations.
  - Pre-negotiated contingency liquidity lines are precedent in Denmark.
- Regulatory responses and guidance:
  - TPR set out a minimum liquidity requirement for pension funds investing in LDI strategies to withstand a 250 bps move in long-dated gilt yields, substantially higher than the 140 bps increase in long-term yields seen in a few days during the LDI crisis.
  - FCA and TPR issued guidance on enhancing resilience in LDI funds: realistic contingency planning, appropriately designed stress tests, and ensuring clients can deliver collateral within five days.
  - Overseas regulators of pound-denominated LDI funds engaged with fund managers to improve resilience across Europe (CBI, 2022).

### 4.C Central bank liquidity backstops for systemic NBFIs
- Role of market intelligence in BoE intervention:
  - Timely market intelligence helped tailor the BoE’s response; confirmed high leverage and the need for swift intervention.
  - A repo facility for LDI funds was ruled out; targeted gilt purchases were chosen as the best option.
- Design and communication of interventions:
  - BoE intervened by pausing planned active gilt sales and setting backstop pricing relative to market prices, purchasing only as much as required to restore orderly functioning.
  - Central bank asset purchases during a tightening cycle can complicate price stability goals and raise moral hazard concerns.
  - Transparency and clear communication are critical when opening central bank liquidity support to NBFIs, especially if measures are prolonged and untargeted.
  - BoE’s firm communication on the temporary and targeted nature of the intervention and on the need for pension fund recapitalization was critical.
- Expanding central bank operational frameworks:
  - For entities with collected data, appropriate supervision, and systemic interconnectedness, consideration could be given to grant access to a central bank liquidity backstop focused on maintaining functioning of core markets (such as gilts and gilt repos).
  - Inclusion of certain NBFIs in the BoE’s operational framework could improve options in future stress situations.
  - Design of facilities should reflect NBFIs’ diverse nature and include safeguards keeping risk in the marketplace to avoid moral hazard.

### 4.D Overall surveillance of the NBFI sector
- Limits of prior stress analyses:
  - FPC’s past stress analysis underestimated extremes; a 2018 FPC assessment concluded most non-banks had sufficient liquid assets for a 100 bps interest rate shock, noting “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 move in late September exceeded this and liquidity shortfalls increased exponentially.
  - The FPC’s 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 market turmoil, pension funds raised £40 billion in cash, whereas 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) exercise:
  - FPC’s planned SWES focused on NBFI risks is a welcome step to improve understanding of NBFI-related vulnerabilities.
  - The voluntary exercise intends to cover most systemic NBFIs and their links to banks, both domestic and domiciled abroad, and core markets.
  - SWES should help identify and possibly quantify risks including hidden leverage and channels of systemic risk propagation, and help close some NBFI data gaps.
- Ongoing monitoring:
  - Continued horizon scanning is required because the NBFI sector is diverse, evolving, and adapting; continued monitoring and improved assessments are required.

### 5. Concluding Points
- The LDI stress episode echoes past NBFI vulnerabilities—liquidity stress, leverage, and interconnectedness—and was not completely idiosyncratic.
- The episode was triggered by a fiscal event resulting in historical moves in gilt yields that exceeded standard stress test parameters; reverse stress testing can help identify extreme scenarios and develop contingency plans and risk mitigation strategies.
- Market intelligence complemented available data during the crisis and was key for real-time decision-making; SWES could contribute by identifying key market players and behavior under stress.
- Cross-border nature of NBFI activities requires international coordination to address vulnerabilities and avoid regulatory arbitrage.
- Clear and regular communication among regulators and with the public is crucial, especially given perceived tensions between monetary policy and financial stability; timely communication helps market participants understand the purpose of authorities’ actions.

*Source: Putting Out the NBFire: Lessons from the UK’s Liability Driven Investment Crisis, Working Paper No. WP/2023/210 — Section 4. Key Takeaways.*

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_Source: https://www.imf.org/-/media/files/publications/wp/2023/english/wpiea2023210-print-pdf.pdf_