UK pension funds hedged with leverage — a mini-budget nearly wiped them out

UK defined-benefit pension schemes had spent years buying liability-driven investment (LDI) strategies: derivatives and repo positions that let a scheme hedge its long-term liabilities using only a fraction of the matching gilts. On 23 September 2022, chancellor Kwasi Kwarteng announced £45bn of unfunded tax cuts in a mini-budget. Gilt yields jumped by more than any move recorded since 2000, and LDI funds faced margin calls they could only meet by selling the very gilts backing the trade.

The forced selling pushed yields higher still, triggering more margin calls in what the Bank's deputy governor Jon Cunliffe later called a self-reinforcing spiral: had it continued, a large number of LDI funds would have been left with negative net asset value, wiping out the pension schemes' stakes in them and forcing the funds into disorderly wind-ups. On 28 September the Bank of England reversed its own quantitative-tightening plan from the day before and announced it stood ready to buy up to £65bn of long-dated gilts, unlimited in daily size, to restore order.

The intervention worked with far less firepower than advertised — by early October the Bank had deployed just £3.7bn of the £65bn ceiling, because the announcement itself calmed the market. Kwarteng was sacked within weeks and the mini-budget was largely reversed. MPs were later told the gilt rout had contributed to as much as £500bn wiped off the value of UK pension funds; the Bank estimated LDI funds and pension schemes faced more than £70bn in margin and collateral calls in total, a bill a leveraged hedge built to protect them turned into the thing that nearly broke them.