Putting Out the NBFIRE: Lessons from the UK's Liability-Driven Investment (LDI) Crisis

IMF Working Papers, September 29, 2023

Source details

Canonical URL: Putting Out the NBFIRE: Lessons from the UK's Liability-Driven Investment (LDI) Crisis

Title: Putting Out the NBFIRE: Lessons from the UK's Liability-Driven Investment (LDI) Crisis
Authors: Ruo Chen, Esti Kemp
Publication date: September 29, 2023
Core focus: A deeper understanding of the factors that amplified gilt market turmoil after the September 2022 UK "mini-budget" and the implications for monitoring financial stability risks in the broader non-bank financial institution (NBFI) sector.

Central event: Severe stress in the UK gilt market in the aftermath of the September 2022 UK "mini-budget".
Role of LDI funds: Liability Driven Investment (LDI) funds were at the center of the gilt market stress.
Sequence: The episode followed the “Dash for Cash” and “Archegos” stress episodes in the previous two years, highlighting recurring vulnerabilities in the NBFI sector.
Policy response: The Bank of England (BoE) undertook temporary gilt purchases on financial stability grounds in late September/early October 2022 to restore orderly market conditions and enable LDI funds to build their capital positions.
Current state (as described): The gilt market stress and the BoE’s purchases are now fully unwound.

Amplifying factors: The paper seeks to identify the factors that amplified gilt market turmoil and placed LDI funds at the center of the stress.
Intervention assessment: The paper identifies the key reasons for the success of the BoE’s intervention in restoring market order and enabling asset-liability restructuring.
Broader lessons: The episode underscores underlying vulnerabilities in the large and diverse NBFI sector that have cross-cutting implications for financial stability monitoring.

Monitoring gaps: Drawing on the paper and findings of the 2022 UK Financial Sector Assessment Program (FSAP), the paper discusses key gaps related to monitoring financial stability risks in the broader NBFI sector.
Jurisdictional and international implications: The paper highlights policy issues relevant for both individual jurisdictions and international standard-setting bodies concerning NBFI surveillance and systemic risk monitoring.
Areas emphasized for policy attention (as described):
- Bank of England financial stability intervention frameworks and central bank liquidity backstops.
- Liquidity management and central bank liquidity considerations for NBFIs.
- Surveillance and macroprudential oversight of Defined benefit pension funds and other NBFIs engaged in liability-driven investment strategies.

Subjects: Asset and liability management; Expenditure; Financial institutions; Financial sector policy and analysis; Financial sector risk; Financial sector stability; Liquidity; Nonbank financial institutions; Pension spending.
Keywords: Bank of England financial stability intervention; BoE's purchase; central bank liquidity; central bank liquidity backstops; Defined benefit pension funds; Europe; Financial sector risk; Financial sector stability; financial stability; gilt market turmoil; Global; LDI crisis; liability driven investment; Liquidity; liquidity management; NBFI sector; NBFI surveillance; NBFIs; Nonbank financial institutions; Pension spending.