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DB pension schemes celebrate BofE intervention

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Ian Mills, Partner at Barnett Waddingham has commented on today’s news of the Bank of England restarting its QE programme.

“Gilt yields have been rising all year, but this trend accelerated in a big way after the Bank of England’s statement on Thursday and the Government’s mini-budget on Friday.  The increases in yields have been on a scale and level of ferocity unlike anything seen since the mid-1970s,” Mills says.

“The Bank of England intervened this morning, effectively restarting its QE programme, despite previously announcing on Thursday that it would start selling back the extensive holdings of gilts it has bought since the financial crisis.  This caused an immediate sharp drop in gilt yields, although they are still significantly higher than the levels in the middle of last week.

“For DB pension schemes this has mostly been good news – these schemes value their liabilities by reference to gilt yields and, for most, rising yields means an improving funding position. Importantly, most DB pension schemes’ funding positions will now be stronger than they were a week ago.

“However, many schemes have been hedging this risk, protecting themselves against the risk of falling yields increasing their liabilities. Whilst this strategy has been very successful over recent years as UK yields have hit low after low, the operational risks of the strategy have, for some, crystallised in recent days.  As yields rise the hedges need to be collateralised with cash, and some schemes have started to run low of cash and other liquid assets.  The vast majority of schemes have been able to rebalance their asset portfolios quickly enough to raise the cash needed, but some schemes haven’t.  These schemes have been forced to unwind their hedges, and in some cases at the worst possible moment.  After the Bank of England’s announcement this morning yields fell back sharply – schemes that were forced to unwind hedges this week may well have effectively locked-in losses to their funding positions.

“It’s worth reiterating that the vast majority of DB schemes have successfully navigated this period of heightened volatility and have generally come out the other side in a better funded position.”

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