The Bank of England has launched a system-wide exploratory exercise including the risks emerging from non-banks such as pension funds. The BoE's executive director for financial stability strategy and risk, Sarah Breeden, has said further frameworks may need to be built up to strengthen resilience. 

 

The Bank of England on Monday launched its first system-wide exploratory scenario exercise to improve understanding of the behaviours of banks and non-bank financial institutions in stressed financial market conditions.  

 

Through the exercise, the central bank will seek to understand how those behaviours might interact to amplify shocks in UK financial markets that are core to UK financial stability. 

 

Aside from large banks, insurers and central counterparties, it said pension funds, hedge funds, and funds managed by asset managers will also be included. The full list of participants and details of the stress scenario will be published later in the year. A final report will be available in 2024.  

 

The bank said it will be working closely with the Financial Conduct Authority and the Pensions Regulator to bring together data and information and develop system-wide and sector-specific insights. 

Nausicaa Delfas, chief executive of TPR, said: “We are pleased to be working alongside the Bank of England and Financial Conduct Authority on this important system-wide exercise.”  

 

 

The market panic of last autumn has shown that defined benefit pension funds are core players in the gilt market and their behaviour can impact financial stability. 

 

As a result of last year’s crisis, DB pension schemes have had to ramp up their collateral holdings. Rather than the 100 basis point buffer that was common before last autumn’s market panic, the Pensions Regulator now expects schemes to hold a steady state buffer of 250 basis points to absorb yield shocks, on top of day-to-day volatility buffers, as recommended by the Financial Policy Committee in March this year.  

 

This has been “functioning broadly as intended” and helped absorb yield swings between March and late May this year, said Sarah Breeden, executive director for financial stability strategy and risk at the BoE, speaking at a webinar organised by the Westminster Business Forum on Friday. 

 

“We will, though, assess whether there are any lessons to be learned from this recent experience for the implementation of the FPC recommendations and the TPR guidance,” she added. 

 

As pension funds are coming into greater focus at the central bank, so are other non-bank financial institutions.  

 

“We... need to understand how market participants will behave when a stress hits,” said Breeden. “Shining a light on how market participants behave collectively in a stress will help both the bank and you better prepare for such events.” 

 

The sector will “hear plenty” from the central bank once the exploratory exercise is launched, she said, noting that the bank might reach out to pension funds. A speech this week by Lee Foulger, the BoE’s director for financial stability strategy and risk, will outline how the exercise will help the bank better understand system-wide resilience. 

 

Breeden said further frameworks “may need to be built up” so market participants are better prepared for shocks.  

 

“And whether these frameworks address vulnerabilities from leverage or liquidity mismatch, they can draw on the building blocks we've used to calibrate LDI resilience. They should capture both systemic and idiosyncratic risks and account for risks specific to individual participants,” she added. 

 

They should draw on the tables and distributions which include system-wide stresses to calibrate resilience, and the timeframes the calibrations are drawn from should consider the options and incentives for raising additional liquidity that are in place, while operational processes should be improved to ensure this additional liquidity can be supplied in practice, Breeden said.  

 

“Non-banks should not have any impediments to drawing on their liquidity during stress,” she added. 

 

The bank will, not least, need to decide which activities and markets these new frameworks should apply to – Breeden noted that some non-bank regulatory frameworks are in the process of being built already, pointing to a discussion paper on money market funds that was published last year. 

  

What could further resilience frameworks mean for pension funds?

This article has been updated to include the fact the Bank of England announced its exercise on Monday morning.