The Pensions Regulator has welcomed the Bank of England’s system-wide exploratory scenario, saying pension schemes have become more resilient to extreme market movements since the 2022 gilts crisis. However, the Bank’s report warns of market behaviours amplifying shocks, the need for better data and a “significant mismatch in expectations” in the repo market. 

The Bank’s exploratory scenario was launched in June 2023 following the gilt market crisis of autumn 2022, which affected defined benefit pension funds and asset managers. In the report published on Friday, the BoE acknowledged non-bank financial institutions have strengthened their resilience since but said more data is needed and warned the system has vulnerabilities.   

The report suggests issues could still arise despite non-banks' better position as “some of that resilience could deteriorate or change over time, risking greater amplification by the financial sector in the future”.

It argues that further work is required given the other vulnerabilities highlighted by the exercise, such as potential bond market illiquidity. The BoE will invest in its in-house capacity to model system-wide dynamics, and said the Pensions Regulator will seek to improve its data.  

Better data collection is needed to pinpoint any correlated asset sales following market movements, the Bank said. TPR, together with industry, will explore potential improvements to existing data collections for better contingency planning by pension schemes and to reduce risks to corporate bond market functioning.   

“TPR also plans to engage with pension schemes to better understand their behaviour in stressed markets, and explore options to reduce behaviour that amplifies market shocks,” the report added.

Despite the Bank’s clear warnings, TPR was upbeat about the report. Chief executive Nausicaa Delfas said: “This report shows that pension schemes are now more resilient to extreme market movements.” 

She added: “We recognise the important role pensions play in the wider financial ecosystem and continue to guard against systemic risks by understanding how schemes act during stressed market conditions, as well as exploring improvements to our data collection to make sure we keep savers safe.” 

TPR leads an external risk panel consisting of its financial risk team, asset managers, pension schemes and senior consultants, to support the Bank of England’s work.  

The regulator came under scrutiny after the gilts crisis, having failed to put in place liquidity requirements for DB schemes. In November 2022, it issued guidance requiring bigger liquidity buffers in LDI funds, after financial regulators in Ireland and Luxembourg – where many LDI funds are domiciled – did so.

Ultimately, the rise in gilt yields that precipitated the LDI crunch ended up boosting the funding levels of many DB schemes.
      

Markets are influenced by behaviours, and the Bank of England’s scenario found market participants were often able to correctly anticipate the behaviour of other participants, for example where there are investment management agreements between LDI providers and their pension scheme investors.   

However, counterparty and investor behaviours were less predictable in other areas, the Bank said. 

It highlighted “a significant mismatch in expectations in the gilt repo market”, with limited repo financing appetite among banks, so that some non-banks would not get all the repo financing they demand in the scenario.  

“This means there is a risk that even large, sophisticated [non-banks] have less access to finance in a stress than they expect,” the BoE said.  

Banks’ responses suggested that over a third of managers would not have been granted additional repo by any bank for one or more of their funds had they requested it during the scenario.  

Repos, or repurchase agreements, allow pension fund investors to ‘lend’ gilts to banks for cash by selling them with a promise to buy back later at an agreed price. During the gilts panic in 2022, the Bank of England launched a temporary expanded repo facility to ensure liquidity in the system. It extended the type of collateral it would accept for repos to include investment grade corporate bonds. 

The legality of pension funds using repos at all was questioned by some politicians in the wake of the 2022 crisis, as they are considered borrowing despite being sales agreements.