Bank of England strengthens emergency stimulus to help ease market turmoil

LONDON — The Bank of England on Monday announced new measures to ensure financial stability in the UK, building on its intervention in the long-term bond market.

The Bank’s Financial Stability Committee announced on September 28 a two-week emergency purchase program for long-term UK government bonds, known as “gilts”, to restore order to the markets and protect liability-driven investment (LDI) funds from imminent collapse.

The central bank announced on Monday that it would introduce more measures to ensure an “orderly end” to its buying scheme on October 14, including increasing the size of its daily auctions to allow securities to be bought ahead of Friday’s deadline.

“To date, the Bank has conducted 8 daily auctions, offering to buy up to £40bn, and has made around £5bn in bond purchases. The Bank is prepared to deploy this unused capacity to increase the maximum size of the remaining five auctions above the current level to up to £5 billion in each auction,” the bank said in Monday’s announcement.

The auction cap will be confirmed each morning at 9am local time and will be set at 10 billion pounds ($11 billion) on Monday.

The Bank will also launch a Temporary Extended Collateral Reporting Facility (TECRF), which will allow banks to ease liquidity pressures on client funds mired in recent market volatility. Following the unprecedented rise in gilt yields last month, LDIs, which hold substantial amounts of gilts and are predominantly owned by final salary pension plans, were receiving margin calls from lenders.

A margin call is a demand by brokers to increase equity in an account when its value falls below the amount required by the broker.

The TECRF will allow banks to execute what the Bank called “liquidity insurance operations,” which will last beyond Friday’s deadline and ease pressures on clients’ LDI funds.

“Under these operations, the Bank will accept collateral eligible under the Sterling Monetary Framework (SMF), including index-linked gilts, and also a wider range of collateral than is normally eligible under the SMF, such as collateral for corporate bonds,” it said. the bank.

Third, the Bank said it would be ready to use its regular long-term index repo operations every Tuesday, which allow market participants to borrow the BOE’s cash reserves for six months in exchange for less liquid assets, to further ease liquidity pressures on LDI funds.

“This standing facility will provide additional liquidity to banks against eligible SMF collateral, including index-linked gilts, and thus support their lending to LDI counterparties,” the Bank said.

“Liquidity is also available through the Bank’s new permanent Short-Term Repo Facility, launched last week, which offers an unlimited number of Bank Rate reserves every Thursday.”

The unprecedented rise in gilt yields, which came in the wake of the new government’s controversial fiscal policy announcements on September 23, prompted Bank of England staff to work through the night before launching their bailout. on September 28.

The Bank revealed last week that some LDI funds were hours away from collapsing the next morning, which would have shocked the UK economy.

Bob Parker, an adviser to CBP Quilvest, told CNBC on Monday that the new measures would likely ease market concerns in the short term, but “a number of significant issues” continue into 2023.

“The first major issue is obviously that the Bank of England will have to raise its base rate further – the consensus is that as we go into 2023 base rates of plus or minus 4.5% are the central case,” he said. Parker.

“Obviously that has implications for gilt yields, which then goes back to structural issues with LDIs.”

Parker suggested that UK regulators “underestimated” the leverage in these LDI funds, leaving them exposed to collateral obligations and margin calls when yields surge.

He anticipates that gilt yields will rise further, with the 10 years it is already up more than 100 basis points in the last month.